Thursday, October 19, 2006
The chart below shows the Healthcare Sector Ishares going back to 1999. It is easy enough to say it, but more difficult to believe it, but this past week, Healthcare broke to a new 7 year high. This is completely contrary to the plethora of bad news that has surrounded this sector. The Healthcare sector is dominated by the drug stocks and, let's face it, the drugs, in some quarters, are held in as low esteem as their namesakes of the illegal variety. ................................S&P Healthcare........................ So what is the sector doing making new highs when sales and earnings growth are still so meager and lawsuits are as common and curable as a cold? When I showed this to Mike Hull, the first thing he said was: go long the Republicans. By that I think he means that since the Democrats have led the attacks against the drug companies, a break to a new high by the sector would mean that big investors are betting that the Republicans are going to remain in power in the November elections. That is a completely counterintuitive thought because the main stream media has virtually ceded control of at least the House of Representatives to the Democrats. On the other hand, since the break out is coming so near the elections and the Democrats are leading in the polls, the market may be saying that the drug companies can cut a better deal under new political leadership. Unfortunately, that is neither easy to say or believe. I prefer to believe that the agony of the past 7 years, has provided the drug companies with a new model that investors believe is viable and sustainable. That model is based much more on cost savings and a more focused approach to research and development. Even though sales gains have been tough in the sector, many of the main players such as JNJ and PFE have reported earnings growth much higher than Wall Street estimates. From a valuation perspective, the drugs are about as cheap on a relative basis as any group. In our September 16th edition, we showed JNJ was nearly 20% undervalued. That is probably about the average of the stocks in the sector. Having negotiated all these "what ifs," I think the Healthcare breakout should be seen as good news for stocks, in general, because it is such an important sector in the S&P 500. In addition, with the drugs so out of favor among big investors, there is good reason to believe that this breakout will likely get a lot of attention and draw in fresh money. I'll keep you updated as we go.