Wall Street's Health Care Relief Rally Reveals Early Winners and Losers

As hyperactive and reactive as stock markets can be, sometimes they get it right. Witness Monday's relief rally on Wall Street after the House of Representatives cleared the way for the most sweeping changes to health care in 40 years. The major equity averages enjoyed vigorous gains, led for much of the session by, yes, the health care sector.

That's because markets are supposed to be forward-looking -- and even a stopped clock is correct twice a day. As we noted last week about health care stocks, they were already priced for the bad news and were broadly set to rise regardless of the vote. So give the market credit where credit is due, and take Monday's action as a pretty good indicator of the sector's relative winners and losers.

In the short term, at least. As John Stoltzfus, market strategist at Ticonderoga Securities, reminded clients Monday morning: "The real action will follow on an intermediate basis as developments flow." As for the tea leaves today? "The early take on the bill is that it will provide mixed blessing for insurers, will benefit pharmaceuticals and pharma benefit managers and increase costs for business," Stoltzfus said. A drill down into the subsector level bears that out.

Early Winners

Greater coverage (the legislation puts another another 30 million customers, er people, into the system), is a no-brainer in the longer term for hospital operators such as Tenet Healthcare (THC) and Health Management Associates (HMA). That's why their shares rallied more than 10% during Monday's trading.

Also popping were health care providers in the sweet spot of managed Medicaid, but the Street knew that was coming. "Clear winners of health care reform passing would be the managed Medicaid plans," wrote Collins Stewart analyst Brian Wright last week, signaling out Amerigroup (AGP), Centene (CNC), Molina Healthcare (MOH) and WellCare Health Plans (WCG). That's because state budget pressures mean more managed Medicaid involvement to help contain the costs related to the aged, blind or disabled Medicaid populations, Wright notes.

Pharmaceutical and biotech companies also traded broadly, albeit modestly, higher. Major pharmas Pfizer (PFE) and Merck (MRK), for example, and large biotechs Amgen (AMGN) and Gilead Sciences (GILD), all rose fractionally to as much as 2% higher in Monday's session.

Early Losers

As predicted, major health insurers were lower Monday, with United Health Care (UNH), WellPoint (WLP) and Humana (HUM) weighing on the sector. And yet Aetna (AET) and Coventry Health Care (CVH) barely budged. There's no question the new health care bill will pressure the insurance industry's already slender single-digit net profit margins. So what gives?

"Passage of the health care package is good news for [buy-rated] Aetna and Coventry as emphasis gets placed back onto fundamentals," Dave Shove, an analyst with BMO Capital Markets, told clients Monday morning. "With strong commercial businesses, these names are likely to benefit from the closure implied by this event."

Device manufacturers were also trading mixed. The good news is that the extension of health insurance bodes very well for sales because these companies will get a revenue boost by adding millions of newly insured Americans. The bad news that "the incremental benefit of adding more millions of insured people won't take effect until 2014," wrote Feltl & Co. analyst Ernest Andberg.

In the meantime, the device manufacturers will have to pay a sales tax starting next year. That will hurt cash flow in the short term. Major manufacturers such as Alcon (ACL) and Covidien (COV) were left out of Monday's sector rally, while cash-strapped small-cap stocks were among the issues selling off.

Bottom Line for Stocks

Now that health care insurance reform is behind us (or at least the vote on this particular bill -- political battles over health care are sure to continue), the market can turn its attention elsewhere. That may or may not be a good thing. As Ed Yardeni, the bullishly prescient president of Yardeni Research, told clients Monday: "If the stock market declines this week, it may be hard to attribute that to the passage of ObamaCare. There are plenty of other concerns for investors."

After all, the withdrawal of global liquidity is at hand. Last week, India's central bank pulled a surprise rate hike, and the Chinese central bank may have to tighten in light of February's torrid pace of inflation, Yardeni writes. The U.S. Federal Reserve will stop buying mortgage-backed securities this week, and Europe is once again bickering over the Greek debt crisis.

And as if that weren't enough, "bearish technicians are warning that the stock market rally has been running on fumes as indicated by low volume," Yardeni wrote. "Undoubtedly, they will soon start to remind us of the old adage: 'Sell in May and go away.'"