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Eric Dutram

Health Care ETFs in Focus on Obamacare Supreme Court Decision

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In what looks to be the biggest Supreme Court decision since Bush v. Gore, the highest court in the land will give its opinion on whether or not the Affordable Care Act (ACA), popularly known as ‘Obamacare’, is constitutional. The decision looks to come during the final day of the Supreme Court’s session before breaking for the summer and it will undoubtedly be a landmark result either way.

A great deal of the debate is centered on the ‘individual mandate’ or a stipulation in the bill which required all U.S. citizens and legal residents to obtain government-approved health insurance. If people do not get this insurance, they will have to pay a fine as a penalty for not doing so starting in 2014.

Some on the right believe that this is unconstitutional as the government cannot force you to engage in a contact with a private company. They also feel that by giving the government this power, there is no telling what can be mandated next in any industry under the guise of doing it for the public good (read Invest Like The One Percent with These Three ETFs).

Meanwhile, those on the left believe that the individual mandate is nothing more than a tax, no different than social security or Medicare, each of which we are forced to pay into already as a form of insurance. Beyond that, the left’s arguments can also consist of a focus on the Commerce Clause, which gives Congress the ability to regulate economic activity connected to interstate commerce, presumably such as health care.

This issue is at the crux of the health care debate and it appears to be the main focus of the constitutionality in the Obamacare law. With that being said, it should be noted that there are realistically three outcomes for Thursday; the entire bill is constitutional, the mandate is unconstitutional but the rest of the bill is acceptable, or that the mandate is unconstitutional and ‘unseverable’ from the rest of the bill, rendering the entire ACA bill unconstitutional.

Likely Outcomes

I think it is fair to say that both sides make some excellent points regarding the debate and that this issue really could go one way or another. However, while the decision may still be uncertain, the markets and many participants in the process are starting to believe that the court will rule against the mandate but leave the rest of ACA intact (see Could The Small Cap Health Care ETF Be A Great Pick?).

In fact, Intrade, an online prediction market, currently has the chances of the individual mandate being ruled unconstitutional (before the end of the year) at roughly a three-out-of-four rate. Additionally, a poll of legal experts now expects the Supreme Court to find the individual mandate unconstitutional, although not by a wide margin.

While it is also possible that the Court can postpone the decision to later on in the year, many view this as unlikely. Probably also out of the cards is the Court postponing a decision due to the ‘Anti-Injunction Act’ suggesting that the ruling will be coming sooner rather than later for Obama’s hallmark piece of domestic legislation.

Stock Market Impact

Clearly no matter what happens, health care stocks and the sector at large will be in focus. Many companies have literally billions to lose on the decision and since it is still so uncertain what actually will happen, we could see a volatile period for the industry in the near term (read 11 Great Dividend ETFs).

While looking at the decision on a stock-by-stock basis is certainly one way to go, many people believe that the results of the decision are likely to impact securities from an industry perspective instead. For investors subscribing to this belief, there are a wide number of ETFs that can provide exposure to the health care sector, breaking down the space into a number of niche industries.

In total, there are 20 health care ETFs on the market today that have a U.S. focus. While there are a number of broad health care ETFs (such as XLV, VHT, or IYH), there are also a variety that have a more targeted focus including several that target the biotech (XBI, FBT, or BBH), medical device (IHI), healthcare provider (IHF), and pharmaceutical segments (PJP, PPH, or XPH).

In the chart below, we have highlighted what we believe are the likely outcomes for each of the major categories of health care ETFs after the long-awaited decision is finally released:

In summary, if the individual mandate is thrown out, it looks likely to spell bad news for the entire sector. That is because the mandate would add a ton of cheap-to-ensure people to the rolls of HMOs-- like with United Healthcare (UNH)-- while it would drive up demand for devices, services and drugs, helping pretty much the entire industry.

If the bill is upheld in its entirety, a much more mixed outlook could be the result. With that being said, it will definitely be a big win for pharma (and companies like Johnson & Johnson (JNJ - Analyst Report) or Pfizer (PFE - Analyst Report), and to an extent, healthcare providers and service companies as well. However, medical device makers look likely to be hurt by the ruling due to new taxes, while biotech could suffer from a similar issue as well (see Medical Device ETFs: A Better Way To Play Health Care?).

Lastly, if the entire bill is deemed unconstitutional, which at this point seems unlikely, it also could produce a mixed result. Broad health care is likely to stay about even, but investors could see a modest uptick for device makers and biotech, while pharma and the HMO market could be losers due to lower demand for their services.

Beyond these unleveraged choices, investors also have a few ways to play the decision with leverage. In total, there are four ETFs in this segment of the fund world, offering investors exposure to both bull and bear 2x strategies as well as both directions in 3x form as well:

ProShares Ultra Health Care ETF (RXL)/ ProShares Ultra Short Health Care ETF (RXD)- These two products track, respectively, the 2x and -2x versions of the Dow Jones Health Care Index. This benchmark is heavily weighted towards big pharma, but it is still relatively spread out among its 122 securities.

Direxion Daily Healthcare Bull 3x Shares (CURE)/Direxion Daily Healthcare Bear 3x Shares (SICK)- These two products track, respectively, the 3x and -3x versions of the Health Care Select Sector Index. Much like their ProShares counterparts, these funds have a focus on big pharma, although they have a heavier level of concentration in their top securities, only holding 52 stocks in total (read Understanding Leveraged ETFs).

While the volumes on these products aren’t exactly the most robust in the ETF world-- suggesting relatively wide bid ask spreads-- they could see higher levels of activity leading up to and immediately following the in-focus decision. Given this, these products could be the way to play the situation, although investors should be prepared for a great deal of volatility and uncertainty no matter what health care stocks or ETFs they hold immediately following the pivotal Supreme Court ruling.

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Follow @Eric Dutram

Author is long PBE, PFE.

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