MAKING A BULLISH CASE FOR HEALTHCARE -- BIOTECHS ARE FINALLY TURNING HIGHER

HEALTHCARE IS TOP APRIL GAINER ... Last Monday I wrote about healthcare being the top sector gainer for the month of April (May 02, 2005). I've also written several bullish articles on the revival of this group over the last couple of months. I believe that healthcare is the most attractive market sector at this time. Not only because of its defensive qualities, but because it appears to be in the early stages of showing new market leadership. Chart 1 shows the Health Care Sector SPDR (XLY) trading at the highest level in nearly a year. Its relative strength line bottomed last December and has been rising since then. Initially, healthcare leadership came from HMOs. More recently, drug stocks started to pull it higher. Even more recently, a handful of biotech stocks are helping to pull it higher. Let's take a longer-range group at the healthcare sector's performance.

Chart 1

HEALTHCARE RELATIVE PERFORMANCE ... Chart 2 gives a better look at the performance of the healthcare sector since 2000 -- both on an absolute and a relative basis. The top line (the Healthcare SPDR) is moving up to challenge its early 2004 high. It's not that far from its early 2000 peak either. Compare that to the S&P 500 (red line) since 2000, which has recovered only half of its 2000-2002 decline. Another way to compare the two indexes is with relative strength (ratio) analysis. That also shows some interesting trends.

Chart 2

HEALTHCARE PROVIDES DEFENSE ... Chart 1 showed the relative strength ratio of the XLV vs. the S&P 500 turning up in the fourth quarter of last year. Chart 3 puts that upturn into better perspective and helps us to draw some conclusions about the defensive qualities of healthcare. The weekly bars show the bull market in the S&P that started in October 2002. The green line is the relative strength ratio of the Healthcare SPDR (XLV) divided by the S&P. Notice their inverse correlation. The upturn in the S&P in the first quarter of 2003 started a two-year period of underperformance by healthcare. That's perfectly consistent with the tendency for defensive groups to underperform when the market is rising. A rising market favors offensive stock groups (like technology) and ignores defensive groups (like healthcare). To the bottom right of Chart 3, however, the ratio has broken its two-year down trendline. That tells us two things. The market has turned defensive. And healthcare stocks are back in favor. Let's go back even further in time.

Chart 3

HEALTHCARE IS GOOD WHEN MARKET ISN'T ... Chart 4 is exactly the same as Chart 3. Except that it goes back six years. The weekly bars show the S&P 500. The green line is the ratio of the Healthcare SPDR (XLV) divided by the S&P 500. Their inverse correlation is even more striking during the bear market of 2000-2002 and the bull market that started in early 2003. The first green circle shows the XLV/SPX ratio turning up in the second half of 2000 as the S&P entered a major bear market. That means that defensive money moved into healthcare and did relatively well. The red circle shows the ratio turning down in the spring of 2003 as the S&P 500 began its cyclical bull market. Healthcare under performed the S&P for the next two years and money moved to more aggressive market groups. The last green circle shows the XLV/SPX ratio turning up for the first time in two years. The ratio line provides us with two useful pieces of information. Not only does it tell us when healthcare is in or out of favor. The direction of the ratio tells us something about the market itself. When defensive stocks move into a leadership role, that's the market's way of warning us that its cyclical bull run is probably over.

Chart 4

TODAY'S HEALTHCARE LEADERS ... The next three healthcare stocks are all achieving upside breakouts today. Caremark is breaking through its January high on rising volume. Humana is also hitting a new high. Genzyme broke out late last week on rising volume and is up again today. That's giving a boost to the biotech group which has been a healthcare laggard but is starting to gain some traction.

Chart 5

Chart 6

Chart 7

BIOTECH GROUP JOINING HEALTHCARE RALLY ... The biotech group is finally starting to show signs of life, which is reflected in a rising Biotechnology Index (BTK). The BTK is trading at a three-month high and is over its moving average lines. Its relative strength line has been rising since March. That shows new leadership by the group. That suggests that some healthcare money is finally moving into the group. The weekly bars in Chart 9 also paint a positive picture. The two converging trendlines starting over a year ago have the look of a bullish "symmetrical triangle". Notice also that the weekly MACD lines (and histogram) have just turned positive. That should give an additional boost to the healthcare sector. I've been asked several times lately where to put some money in an uncertain market. My sector favorite right now is healthcare.

Chart 8

Chart 9