Healthcare Stocks Taking Off as Tech Companies Tumble (IHF, XSD, HUM, WLP, UNH, FNSR, JDSU, ALTR, LRCX, TXN, CVH, GOOG, AMZN, NTAP)

Jon D. Markman:  Technology and commodities companies have been among the hardest hit over the past few weeks, as major players move from cyclical stocks to more defensive areas like healthcare stocks.

In the technology sector, the worst of the sell-off has been in the optical stocks. That’s a shame because many of these stocks finally looked like they were on the verge of emerging from long bear markets. But the optical stocks – so popular during the tech bubble – were kicked in the head when Finisar Corp.(Nasdaq:FNSR) issued a very weak outlook for its April quarter.

Finisar shares lost 38.5% last Wednesday and fellow industry giant JDS UniphaseCorp. (Nasdaq:JDSU) took a 17% hit. Just two months ago, we were talking about how it looked like these guys were back – well, so much for that.

Semiconductors are also on the run, with Altera Corp. (Nasdaq:ALTR) down more than 7.5% in the past week andLam ResearchCorp. (Nasdaq:LRCX) down 10.5% in that time. These companies had been very popular until about two weeks ago, so it’s remarkable how quickly sentiment can change.

I’ve been racking my brain for an explanation as to how the semiconductor companies could go south so fast, and I have come up with four rationales.

The first is structural. You may have heard that Carl Icahn is closing his hedge fund and returning money to investors. Several other smaller hedge funds recently made similar announcements.I would not be surprised if these funds are liquidating their growth-stock holdings three weeks before the end of the first quarter.

The second rationale is legal. The Galleon hedge fund insider trading trial is finally starting in a New York federal court. The witness list was recently leaked and there was a lot of speculation that Raj Rajaratnam, the main target of the case, might reach a plea bargain with prosecutors before the trial began. Also, very late in the game, the government has named three McKinsey & Co. consultants as targets of the investigation.

Galleon traded a lot of technology stocks, and McKinsey consulted at the highest level for a lot of those same firms. Investors that own sizeable stakes in any of the tech companies that could be mentioned during the trial may be dumping their shares for fear those companies will receive negative publicity.

My third rationale is fundamental. Texas Instruments Inc.’s (NYSE:TXN) earnings update was very disappointing. One of the key drivers of upside in stocks is the potential for positive surprises relative to expectations. TXN told us that expectations might actually be too high – not too low – in some of the most important growth areas: mobile and baseband.

The big miss by Finisar confirms that view. Moreover, I received some analysis by an independent institutional research provider that appears to show earnings growth and inventory build for the sector may have peaked last quarter.

And my fourth, and final, rationale is crowd behavior.Technology has become a crowded trade. The opportunities in mobile broadband were fresh ideas three years ago. Now they’re conventional wisdom. Some of the biggest names in the sector have stalled. Cavium Networks Inc. (Nasdaq:CAVM), NetApp Inc. (Nasdaq:NTAP), Amazon.com Inc. (Nasdaq:AMZN) and Google Inc. (Nasdaq: GOOG) are all rolling over.

There will still be huge opportunities for all these companies in the years ahead, but expectations may have run ahead of prices. All of these stocks are still well above their 200-day averages, and thus in bull mode, but the passion among investors is gone for now.

So as investors we may want to turn our attention elsewhere for the time being. And that brings me to the healthcare sector.

The Key to a Healthy Portfolio

The healthcare sector is fascinating because its strength is not coming from the typical value/defensive aspects of the industry – i.e. drug makers. Instead it’s coming from managed care stocks.

Since Feb. 24, the iShares Dow Jones US Healthcare ETF (NYSE:IHF) fund is up1%, while the Standard & Poor’s 500 Index is down nearly 2% and the SPDR S&P Semiconductor ETF (NYSE:XSD) is down 7%.

Positive comments from management coming out of recent investor conferences have helped improve sentiment for companies like Humana Inc. (NYSE: HUM), Wellpoint Inc. (NYSE: WLP), UnitedHealth Group Inc. (NYSE: UNH), and Coventry Health Care Inc. (NYSE:CVH).

These healthcare stocks are no longer being ignored and they’re undervalued relative to other so-called “growth” stocks.

Brokerages have weighed with upgrades, as well, following the resolution of uncertainties surrounding the new healthcare legislation and a renewed appreciation for these companies’ predictable operating fundamentals.

Thinking about why managed healthcare might be advancing at a time when energy is the only other prominent out-performer led me to recall another similar span in the market, which was not too long ago. That was the rather odd period of 2004-2005.

People remember the 2003-2007 period as a great bull market, but they conveniently forget that 2004 and 2005 were largely flat for most stocks. 2004 was actually negative until the final three months of the year and 2005 was a snoozer in which the S&P 500 gained only 3%.

While industrials, tech companies and drug makers sleepwalked through that period, energy and managed care stocks performed very well. In fact, some of the leading healthcare companies, mentioned above, rose 100% in that two-year span.

These stocks were appropriately massacred from 2006 to 2009, losing around 60% of their value, but they now seem quite perky, with rising earnings and upside surprises.

Still, the most important part of the story is not their earnings – it’s that these companies offer a good hedge against any shakiness in the economy for the rest of the year. At the same time, they should perform in line during stronger periods at a minimum. So put them on your radar.

Jon D. Markman brings a unique perspective and unparalleled insights to his role as a Money Morning contributor. And with good reason: During the past two decades, Markman has worked as both a journalist/commentator and as an actual portfolio manager. In addition to his contributions to Money Morning, Markman manages The Markman Portfolios, and is the editor of two premium investment research services: Strategic Advantage and Trader’s Advantage.

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