April 8, 2006
The overall market choppiness since the beginning of 2006 has made it tough for investors to find trading opportunities. However, there are a handful of developing bullish and bearish sector trends that are worth a closer look. All of these trends are based on weekly - and even monthly - data, which weeds out the day-to-day noise that has been unusually loud over the last month. As such, a day or two worth of contra-movement can’t be taken to heart. These ideas are much ‘bigger picture’.
The Stealth Rally
Although the NASDAQ has lethargically trailed the S&P (as well as the Dow) in hitting new highs, many traders may be surprised to know that technology stocks have actually had a pretty good year. At no recent point has the sector been a top-performer, but it’s in the top three or four sectors in 5-day, 20-day, monthly, and six-month rankings. The fact that it has consistently been strong without ever being red hot has allowed the sector to quietly develop some momentum, without inviting waves of profit-taking that eventually cause in implosion. In other words, tech is in a nice stealth rally that is likely poised to continue.
The average tech stock P/E is at 32.2, which actually isn’t bad for technology. Profit margins are at a decent 10.17 percent.
The chart of the Dow Jones Technology Index (DJUSTC) looks like it may finally reward investors who have been waiting patiently for the fundamental data to work its way into share prices. The index had met resistance around 540 several times since 2002, including a handful of recent encounters. That persistence has paid off, in that the index is now 550, and still itching to go higher. Its MACD lines are showing a renewed acceleration.
Realistically, we’re watching 600 as a potential reversal point. That’s the high point reached in early 2002, and was also the last gasp before the death blow was inflicted that sent the index to 250 by October of that year. If we get past that level, then the tech stocks could really get moving, especially if the fundamentals continue to improve as they are. And even if 600 is a problem, that would still mean about a 9 percent gain between here and there.
Software - The Stealthiest of the Stealth
Of all the technology industries that are doing well, software appears to be the most viable opportunity. That’s not because it’s leading the pack, but because it has trailed all the major industries in the sector over the last six months. Since October, the average software stock has gained 15.4 percent……and that’s the weakest industry. The fact that it has lagged, though, just means these names are still at least a little undervalued. Pair that fact up with a chart of these stocks, and you have a pretty interesting investment idea.
In fact, the chart of the CBOE GSTI Software Index (GSO) pretty much mirrors the Dow Jones Technology Index, in that it’s developing some momentum while working to break above some resistance. The CBOE Software Index chart’s key resistance line is at 176, where it topped out in late 2004. After a good-sized correction, the index is back up to 172, and itching to go higher on the heels of its newly-found buyers.
To view charts of the Dow Jones Technology Index & the CBOE Software Index, click here: http://bluegrassportfolio.com/sectorwatcharchives/040806sectorreview.html
The average software company P/E is 25.1, while the net profit margin is 23.5 percent. Both of those measures are basically tops within the tech sector, which is precisely why the market should be giving a strong second look to software names.
Healthcare - Still in trouble, thanks to pharmaceuticals
While the broad healthcare sector should almost always be a core component of any portfolio, it doesn’t change the fact that these names have been a surprising disappointment over the last few months. Since this time in October, the healthcare sector is up 6.2 percent. That only tops consumer staples and utilities, which have six-month gains of 6.1 percent and 5.3 percent, respectively. The S&P 500, however, has improved by 8.8 percent during that time. That may seem like a trivial difference. But, given that that the average return of the sectors that have beaten healthcare stocks since then is a whopping 18 percent, what you have is a clear reason to focus on the top performers, and avoid the weak areas such as healthcare.
The chart of the Dow Jones Healthcare Index (DJUSHC) illustrates the problem very well, with a tumble from 325.94 to 314.77 right now that triggered a bearish MACD crossunder signal. Such a signal is no small matter, as they have historically spotted the beginning of rather large downward moves. Is this dip justified? The typical healthcare P/E is 31.4, and margins are a decent 11.2 percent. That’s actually respectable, so why is the sector still struggling? An investor should know that the healthcare sector’s single biggest component is pharmaceutical stocks, which have literally been dragging down the sector.
The pharmaceutical stocks are truly the only major group to not participate in this bull market. At all. Between March of 2003, which was the end of the bear market and beginning of the market recovery, the Dow Jones Pharmaceuticals Index (DJUSPR) is down by 9.7 percent. By comparison, the S&P 500 is up 53.4 percent. And sadly, the losing trend for pharma doesn’t look like it’s going to end anytime soon, primarily for fundamental reasons.
The entire pharmaceutical industry has been falling for so long, the market doesn’t really know how to do anything with these stocks except sell them. Old habits like this are hard to break, as we saw just last month when the rally attempt failed. The Dow Pharmaceuticals Index was able to reach as high as 262.61, but then came tumbling down to 252.43 by the end of March. The current reading of 251.50 is only making the matter a little worse. As a result of that selloff, a couple of key resistance lines were defined. These lines extend all the way back to early 2004….evidence of just how long and things have been tough on the likes of Pfizer (PFE), Johnson & Johnson (JNJ), and Glaxo (GSK).
The toughest part for these companies is that they’re actually doing pretty well in terms of sales and profits. It’s just that the underlying stocks aren’t reflecting that performance. The average P/E of 19.30 makes them a bargain, and profit margins of 18.0 percent should be attract to most anyone. Yet clearly, these stocks continue to go unloved. At some point in time, the market will look past the history of these companies and their stocks, but until that happens, investors are content to leave big pharma alone.
But even taking the pharmaceutical stocks out of the equation, the healthcare sector just doesn’t seem to be able to get anything bullish going. The healthcare providers and equipment providers are both I the red for the year, while biotech is barely in the plus column so far. The leading healthcare sector year-to-date is, ironically, pharmaceuticals. In the grand scheme of things, though, the bearish illness seems to have infected the entire sector.
James Brumley is a freelance writer and investment manager. His company Bluegrass Portfolio Management offers retail and institutional investors a performance-oriented recommendation service. Visit http://www.bluegrassportfolio.com for more information.
Mr. Brumley can be contacted by e-mail at james@bluegrassportfolio.com.
Bluegrass Portfolio Management, LLC is registered with the state of Kentucky, under the Kentucky Securities Act. All information contained herein is for informational purposes only for U.S. residents and does not constitute a solicitation or offer to sell securities or investment advisory services. Such an offer can only be made in states where Bluegrass Portfolio Management, LLC is registered or where an exemption from registration is available. Representatives of the firm may only conduct business in a State if the firm and its representatives are approved to do business in the State or are exempted from its registration requirements.
