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Medical Devices: Selloff Safe Haven

Posted: Aug 24, 2007 12:28 PM by Matthew McCall

Tickers in this Article: ISRG, TMO, MDT, IHI

In times of high volatility and uncertainty in the market, investors often search for a safe place to put their money. In reality, what investors seek is an investment that offers exposure to the market for any potential rally while at the same time protecting them from further losses.

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Unfortunately, there is no stock or exchange-traded fund (ETF) in the universe that can guarantee gains and eliminate risk completely.

The next best option is to look for investments that have held up well during a pullback and rallied with the overall market during a raging bull market. In the world of ETFs there were few options to choose from due to the market-wide weakness in August; however, one niche area did make the grade.

Hiding Out in Medical Devices
The iShares Dow Jones US Medical Devices ETF (NYSE:IHI) has held up very well against the overall market and other health care ETFs. While the S&P 500 fell straight through its 50-day moving average and spent a week below the 200-day moving average, IHI only traded below the 50-day for two days before it rallied back. Moving averages are often used by technical analysts to determine the current trend of the chart. An ETF trading above the 50-day moving average can be classified in a short-term up trend and vice versa.

The 200-day moving average is utilized when analyzing the long-term uptrend of the ETF. Therefore, IHI has stayed within the short-term and long-term uptrend for all but two days and at the same time the S&P 500 broke the short-term and long-term uptrend during its pullback. What this shows is the relative strength of IHI versus the overall market.

From the closing high on August 8 to the close on August 16, the lowest in a month, the total pullback was less than 5% for IHI. This compares to a 10% pullback for the major indices off their highs over the same time period.

There is no "scientific" reason for the outperformance, other than investors were looking for a sector that was far away from the perceived credit crunch. Combined with the solid long-term outlook for the sector based on the emergence of the baby boomers, it was a no-brainer for big money to hideout in the medical device stocks.

Analysis of IHI
The ETF is designed to track the movement of the Dow Jones U.S. Medical Device Index, which is currently composed of 39 stocks in the niche arena. As the name displays, all the companies in the ETF are based in the United States, but that doesn't mean there are zero sales overseas. With companies of this size there will be a significant number of sales outside America.

The top 10 holdings make up 58% of the entire allocation and, therefore, are an important aspect when analyzing this ETF and they are clearly a major reason why IHI has been able to avoid the selloff. Of the 10 holdings, seven are currently trading above their respective 200-day moving averages. With less than half of all stocks on the NYSE able to do the same, the components of IHI have collectively outperformed the market.

Leading the IHI Move
The No. 1 holding of IHI, Medtronic (NYSE:MDT), makes up approximately 13% of the entire ETF. Medtronic is a world leader in supplying medical devices such as defibrillators and pacemakers for cardio issues, orthopedic equipment and diabetes management supplies. The cardiac-rhythm-management products division accounts for 42% of sales and is an area MDT is known as the leader. Its diabetes division, which currently accounts for 17% of sales, is expected to be one of the high growth areas in the coming years.

Another top five holding that is not the typical medical devices company is Thermo Fisher Scientific (NYSE:TMO). The company focuses on offering laboratory equipment and analytical products to the healthcare industry. The large company offers over 600,000 different products and services to anyone in the laboratory and research sectors. Last year, sales grew 44% and the P/E ratio, based on 2007 earnings, trades at a very reasonable 20-times.

Not in the top five, but landing in the top 10, is perhaps the best growth story of all medical device stocks, Intuitive Surgical (Nasdaq:ISRG). The company developed the da Vinci Surgical System, which is a robotic surgery system used to make procedures less invasive. Even though ISRG is trading at a P/E ratio of about 80-times, the growth is the reason the stock is up over 1100% since the beginning of 2004. Earnings are expected to come in at $3.11 per share in 2007 and jump to $4.20 per share in 2008, an increase of 35%. If it is growth you want, ISRG is your play!

Conclusion
The relative strength shown by IHI and the entire medical device sector during a market-wide selloff is enough to make it attractive for long-term investors. Add in the fact IHI is up 13% this year as the S&P 500 is flat and it shows it can move higher when the market decides it is ready to run. The bonus is the added demand the sector may get with the aging of the baby boomers over the next couple of decades. So, if you are looking for a device to help you through the volatility, look no further!

To learn more, see 3 Steps To A Profitable ETF Portfolio.

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By Matthew McCall

Matthew McCall is the president of Penn Financial Group, LLC, a registered investment advisor. He also publishes two newsletters, The ETF Bulletin and The PFG Letter as well as other educational material. As a registered investment advisor, he manages clients' investments based on their specific goals and objectives.

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