From David Fabian: When looking over the last decade of sector returns on a year-by-year basis, it’s rare to see health care fall to the bottom of the stack. Yet that unusual event is exactly what occurred in calendar year 2016.

Over the last twelve month, the Health Care Select Sector SPDR (XLV) posted a total return of -2.76%. That final performance includes dividends and carries the stigma of being the only major S&P sector to finish the year in negative territory. To put things in perspective, energy stocks gained 28% in total return over the same time frame.

XLV is the largest exchange-traded fund in the health care sector with $13.5 billion dedicated to a basket of 62 large-cap stocks. Top holdings include well-known names such as Johnson & Johnson Inc (JNJ), Pfizer Inc (PFE), and Merck & Co Inc (MRK). Companies focused on biotechnology research, pharmaceutical development, health care provider, and equipment services are all represented in XLV through a market-cap weighted asset allocation.

A look at the chart below shows the meandering path that this ETF has taken over the last year. It now stands 8% below its prior 52-week high and has frequently jostled above and below its long-term 200-day moving average.

The picture becomes even more bifurcated at the industry level. The iShares NASDAQ Biotechnology ETF (IBB) lost more than -21% in 2016 and continues to whipsaw in a violent sideways range. Furthermore, pharmaceutical companies have frequently been in the spotlight as a divisive issue over the course of the presidential election cycle. This negative sentiment has taken a toll on the PowerShares Dynamic Pharmaceuticals Portfolio (PJP), which is currently off -28% from its all-time high.

Investors evaluating the future for healthcare stocks are likely to see one of two distinct paths.

Momentum and trend following advocates will probably shy away from the weak relative performance and lack of attractive technical cues. Those who favor this style are likely to be drawn towards alternative sectors that are continuing to move in lockstep with the broader market or show a definable trading edge to higher prices.

On the flip side, many will see the weak one-off year as the potential for an undervalued area of the market to make a significant comeback. Several large-cap health care stocks offer attractive fundamentals and this group may be an unlikely candidate for a bounce on any type of sector rotation events in 2017.

ETF investors who own broad-based factor strategies that target volatility, momentum, or value would be wise to understand the impact of this sector on their holdings as well. Many smart beta funds will be rebalancing their holdings in January based on prior performance or relative valuation metrics. That may increase or decrease your health care exposure based on the rules-based criteria of each index.

From a benchmark perspective, health care is the third largest component of the S&P 500 Index with a 13.6% asset allocation share. The size advantage means this sector has the potential to make a big impact on the market overall alongside individual investor portfolios.

The Bottom Line

The dispersion of individual sector returns in any given year is always an interesting study in market dynamics. These trends are typically driven by asset flows, investor narratives, or global economic forces. How you ultimately interpret the data and apply it towards your own portfolio is where the greatest impact will be had.

Health Care SPDR (ETF) (NYSE:XLV) was unchanged in premarket trading Thursday. Year-to-date, XLV has gained 2.10%, versus a 1.36% rise in the benchmark S&P 500 index during the same period.

XLV currently has an ETF Daily News SMART Grade of B (Buy), and is ranked #6 of 36 ETFs in the Health & Biotech ETFs category.

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This article is brought to you courtesy of FMD Capital.

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