Drug Free

The point I’d like to make today, however, does not concern the Nasdaq. Rather,
it concerns the “new glamours” we have been witnessing for the past
several months:  the Pharmaceuticals.  Stocks like
(
MRK |
Quote |
Chart |
News |
PowerRating),
(
JNJ |
Quote |
Chart |
News |
PowerRating),
(
LLY |
Quote |
Chart |
News |
PowerRating) and their peers have been labeled the ‘safest’ stocks to own in the
current market environment.  For the past few weeks we have witnessed an
all out assault on our senses about how  “safe” and “recession
proof” the drug stocks are and how they are “reliable earners”? 
Really?  Safe at what price?

After the close of trading today, we saw YET another special segment on
television focused on the major drug stocks. We saw multiple pharmaceutical fund
managers give their opinions on how the entire sector was poised to go higher
and how bulletproof their earnings outlook is.  Do any of you remember
March of this year? (Not all at once… please)  It seemed like a “sure
thing” that the Nasdaq Composite was going to rally farther in 2000 with
many well respected analysts predicting a visit to the 6000 level.  In
addition, we witnessed upgrade after upgrade after upgrade of the technology high-fliers
as they hovered near their 52-wk highs. With the promise of unparalleled
earnings growth and productivity gains forever changing the complexion of our
Markets, it certainly seemed like all the stars were in alignment for further
equity appreciation in the technology sector.  We all know what happened
after that…. it has changed every one of us forever.

With the Pharmaceutical sector trading at a 40%+ premium to the SP 500, to say
they are at the “high end of historical valuations” is the equivalent
of calling Andrew Dice Clay just a wee bit ill-mannered.  Let’s look at
Merck and Co. At a current market capitalization of over 220 billion dollars
(that’s $222,000,000,000 for all of you keeping score at home), MRK has been the
beneficiary of the “white glove” treatment from pharmaceutical sector
analysts and financial media. Too say the least, the valuation is absurd with a
price/earnings ratio near 40 – unprecedented for a major pharmaceutical.What
actually is taking place here?  Let’s look at the chart below:

We can see from the chart above that MRK has rallied considerably from its
levels back in September.  For the past two months, MRK has been trading in
a consolidation range of $88-95.  At the areas indicated above, MRK was
unable to close strongly on the days it upthrusted into the $95 area, thus
creating some very bearish candlesticks.  In addition, the daily MACD has
been continually decreasing as the stock has trading in this range.  This
is a negative divergence and is considered bearish.  With MRK’s bearish
candlestick today, we see further evidence that a topping formation is well on
its way.  Sometimes it takes individual stocks or indices several days,
weeks, and even months to top/bottom as accumulation and distribution occur at
these levels.  MRK has a few gaps on its daily chart that need to be “closed”
should the topping formation come to fruition.  These areas are indicated
above.  Eli Lilly (LLY) is another drug stock that displays a similar
topping formation.

Long Watches: JDSU/SDLI, PMCS, JNPR, MUSE,
VRSN.  Watch BRCM and SCMR for a “catch -up” rally.

Short Watches: MRK, LLY, JNJ, and other
“bullet proof” defensive issues which will get slaughtered should the
Nasdaq continue to rally through January 2001.