DECEMBER LEADERSHIP SHOW CAUTIOUS MARKET -- DRUGS HAVE STRONG WEEK -- HEALTHCARE ETF NEAR RECORD HIGH

JOHN'S LATEST PERFORMANCE CHART ... John's Latest Performance Chart ranks the best and worst groups over the last month. Basic materials, gold, and oil service stocks have benefited from firmer commodity prices. Other sector leaders include healthcare, utilities, and consumer staples. It's worth noting that most of those December leaders are defensive in nature. Meanwhile, retailers and technology are December laggards. That suggests that investors have been turning more cautious over the last month. The most dramatic turnaround has been in the drugs. They were the second strongest industry group for the month, and the top performer for the past week. That also gave a boost to the healthcare sector.

Chart 1

DRUG INDEX HAS BIG WEEK ... The next two charts show the dramatic rally in drug stocks this past week. Chart 2 shows the Pharmaceutical Index (DRG) breaking through its 200-day moving average. Its relative strength line jumped as well. Chart 3 shows the big volume accompanying the jump in Pharm Holders (PPH). The catalyst for the weekly surge was a court judgment supporting Pfizer's patent on lipitor. That gave a boost to the entire group, which spilled over to the healthcare sector. Chart 4 shows the HealthCare SPDR (XLV) climbing to its September high on rising volume. That's because stocks like Pfizer and Merck are heavily weighted in both ETFs.

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DRUGS HAVE BEEN BAD PERFORMERS... The next chart shows how badly the drug group has done during the three year bull market. The group peaked in late 2000 and bottomed in mid-2002. The real story, however, is seen by the DRG/S&P relative strength ratio. The ratio has been falling for the last four years. Part of the reason has to do with problems relating to the industry. Part of the explanation, however, may also lie with defensive nature of drug stocks. They usually do better when the market is weak, and less well when the market is strong. The DRG/S&P ratio fell during 1999 in the last year of that decade's bull market. It bottomed in early 2000 when the Nasdaq market peaked and rose for the next two years. That made drug stocks a good safe haven during most of the bear market. The group then weakened throughout the three-year bull market that started in early 2003. That may qualify the drug group as a possible hedge against an aging bull market that might start to weaken in 2006. The same is true for the entire healthcare sector.

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HEALTHCARE ETF NEARS RECORD HIGH ... The Healthcare Sector SPDR (XLV) is nearing a test of its record high reached in early 2000. The trend of its relative strength ratio is similar to that shown in the previous chart. Healthcare held up much better than the rest of the market during the bear market years from 2000 through 2002. Its performance has lagged during the bull market that's lasted since the spring of 2003. It's ratio is showing signs of turning up again. While that may carry good news for healthcare, it may also be sending a message that investors are starting hedge their market bets for 2006 by rotating into more defensive groups. The big pharmas are the cheapest part of healthcare.

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GOLD IS BOUNCING ... Earlier in the week I suggested that the Gold ETF (GLD) could test its 50-day average and lower Bollinger band before rallying. It didn't quite reach those lower levels but is starting to bounce again. The next chart shows the GLD climbing the equivalent of $7.50 today. The 20-day Commodity Channel Index (CCI) is close enough to oversold territory to warrant a rally attempt. The recent pullback in gold may be nearing completion. It may back and fill awhile longer after its recent sharp runup. But the major trend is gold is still up and short-term setbacks should be viewed as buying opportunities. Part of my optimism on gold is based on the strong performance by gold shares. Chart 8 shows that the recent dip in the Gold Bugs Index (HUI) has been much shallower than in bullion. The HUI/GLD ratio line is breaking out to the upside. That means that gold stocks are leading bullion higher. That's usually good for both. The weekly bars in Chart 9 show that the HUI has maintained its recent upside breakout through the early 2004 high near 260. In addition, the HUI/GLD ratio has broken a two-down trendline. Bullion usually does better when gold stocks are leading it higher.

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SANTA CLAUSE MAY STILL ARRIVE NEXT WEEK... The traditional Santa Claus rally normally kicks in between Christmas and New Years. If it does, it may be the last gasp in the yearend rally. I've been writing about technical deterioration in market breadth figures. Recent sector rotations also reflect a more cautious market. If a Santa Claus rally does arrive on schedule, I'd be inclined to sell into it as opposed to committing new funds to the market. My two favorite markets for 2006 are gold and Japan. It might also be a good time to take a look at healthcare -- and pharmaceutical stocks in particular for reasons described above. I'll probably be out of the office for the rest of the week doing some last minute Christmas shopping. So I'll take this opportunity to wish everyone a very Merry Christmas.