3 Scenarios: What You Need To Know About Obamacare and Health Care ETFs (XLV, IHF)

Michael Johnston: After a slew of announcements early Monday prompted speculation that a decision on health care legislation was imminent, we learned that Thursday will be the day for one of the most heavily anticipated rulings in the last several years. The Supreme Court is expected to issue a ruling on the health care legislation that was passed in 2010, bringing a conclusion to years of legal wrangling and politicking behind the scenes. The justices are expected to issue a split opinion, and analysts have been divided over how they will rule. Given the far-reaching impact of the decision, the health care sector figures to see increased scrutiny and trading volumes throughout the week.

Three Outcomes

Analysts see a wide range of possible outcomes in the wake of the Supreme Court ruling, with potential positives and negatives for the health care industry. In a recent research note, S&P Capital IQ ETF Analyst Todd Rosenbluth outlined three possible scenarios for Thursday’s announcement and gave some thoughts on what each would mean for the health care sector [sign up for the free ETFdb newsletter]:

Scenario #1: Individual Mandate is Constitutional

Under this scenario, which is deemed to be the most positive for the health care industry, the Supreme Court would essentially side with the Obama administration and rule that the mandate for individual insurance is constitutional and can be implemented as scheduled. This could represent a “win” for the health care sector since it would lead directly to an inflow of more than 30 million additional insured customers over the next several years (beginning in 2014).

In the current political environment, however, this scenario could lead to additional uncertainty for the health care industry. Republican presidential candidate Mitt Romney has vowed to repeal the health care package if elected, which could lead to additional doubt over the long term prospects for the law if the November election is close as expected. The implementation and subsequent repeal of the entire law would translate into major expenditures for the health care sector, potentially creating a short term drag on efficiency and profit margins.

This is the “best case” scenario for health care ETFs

Scenario #2: Entire Law Struck Down

Another possibility is that the Supreme Court determines the individual mandate to be unconstitutional, and further rules that the mandate is a primary component of the legislation. That would mean that the individual mandate can’t be stripped out from the rest of the law, and the Court would effectively invalidate the entire law. This would lead to healthcare reform eventually being rolled back entirely, which would likely be a complex process.

S&P sees this as a neutral outcome for the health care sector in general; while the loss of millions of new insured individuals would dramatically reduce growth potential, the elimination of the various fees, taxes, and regulations that are part of the overhaul would disappear as well.

This scenario would likely be neutral to health care ETFs

Scenario #3: Individual Mandate Struck Down, Rest Of Law Upheld

This “hybrid” scenario could be the worst possible outcome for the health care industry. It’s very possible that the Court rules the individual mandate unconstitutional but allows the rest of the law to be implemented as planned. That could be the worst of both worlds for health care providers; the pipeline of 30 million new insured Americans would essentially be emptied, while the various taxes and regulatory burdens would remain in place. According to the Congressional Budget Office, striking down the individual mandate would result in about 16 million additional Americans obtaining health insurance. Many of those would come through the expansion of Medicaid, which would weigh on profit margins of health care companies.

This is the “worst case” scenario for health care ETFs

Health Care & Biotech ETFs In Focus

Broad-based health care ETFs such as the Health Care SPDR (NYSEARCA:XLV) will no doubt be impacted by the decision handed down on Thursday. In addition, a number of more targeted funds will likely react to the news later this week as well. Among the sectors that could rise or fall depending on the decision handed down:

  • Pharmaceutical ETFs: Pharma companies will no doubt be watching the legal developments on Thursday very closely; the Supreme Court’s decision should have a direct impact on demand for pharmaceuticals in coming years. Upholding the law would be the most beneficial scenario for this sector; just as it would funnel tens of millions of Americans towards new insurance, it would result in additional buyers of prescription drugs for years to come.
  • Health Care Providers ETFs: This corner of the market could be very active in coming days, as organizations that provide health care are positioned to see the biggest impact from the ruling. The iShares Dow Jones U.S. Healthcare Providers Index Fund (NYSEARCA:IHF) includes owners an operators of health maintenance organizations, hospitals, clinics, nursing homes, and rehab centers. If the entire law is upheld, expect IHF to get a boost on Thursday.
  • Biotech ETFs: The biotech sector has been one of the few bright spots in 2012; this corner of the market has posted gains approaching 30% on the year. Though biotech has less direct exposure to the ruling than other corners of the health care market, the various biotech ETFs could see some limited impact on Thursday.

Written By Michael Johnston From ETF Database 

ETF Database is committed to giving our audience, consisting of both active traders and buy-and-hold investors, information that, to our knowledge, is truthful and non-biased. [For more ETF insights, sign up for our free ETF newsletter or try a free seven day trial of ETFdb ProETFdb Pro Members Only.]

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