Drug Free

The Nasdaq Composite gave us an impressive performance today, closing near its session high after reversing a negative open. Although the Composite did not exceed yesterday's high of 2548.75, it certainly formed a higher low during this morning's journey down to 2450. All in all, with semiconductor and fiber optics groups leading the charge, I believe we have some firm footing to continue higher. The positive performances from semiconductor and fiber optics bellwethers like (PMCS | Quote | Chart | News | PowerRating), (JDSU | Quote | Chart | News | PowerRating)/(SDLI | Quote | Chart | News | PowerRating), (CIEN | Quote | Chart | News | PowerRating), (JNPR | Quote | Chart | News | PowerRating), (EMLX | Quote | Chart | News | PowerRating) provided some sorely needed leadership. The inability of the Nasdaq Composite to sustain a rally since Sept. 1 has been widely publicized this week.

In my opinion, this morning's weakness prior to the late morning reversal to the upside may have been the Bear trap necessary to drive the Nasdaq higher in the short term.

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.