In recent weeks, the debate over America’s health care system has gotten lots of attention. In the midst of so much uncertainty, one might assume that the health care sector would struggle to advance. In fact, over the past year this sector has made impressive gains and it remains in a powerful upward trend.

With the passage of the health care bill this week, many market watchers assumed the health care sector would slide. Instead, health care positions generally added to their recent gains.

For several months forecasting the financial markets has been a tricky proposition. Many sectors and the equity markets in general have risen when technical and fundamental indicators would normally be pointing to a correction. That situation is recurring in the health care sector right now.

Logically, one might expect a downturn in any sector that just became the target of extensive new government oversight. And since the end of February, most health care positions are overbought according to many technical indicators. Yet the sector keeps advancing.

Part of the reason might be that many traders and investors view health care as a defensive investment. Even when the economy is bad, people still have to visit their doctor or go to the hospital. As a result, health care funds often hold up better than other types of funds during period of market weakness.

The accompanying chart shows iShares Dow Jones US Healthcare (IYH). Over the past year this fund has gained nearly 40%. As one can see on the top portion of the chart, it is currently trending well above its 50-day (gold line) and 200-day (blue line) moving averages.

The two lower sections of the chart are separate technical tools indicating that currently IYH is at an overbought level. In other words, the price and momentum of this fund have reached a point where it is similar to a rubber band that is stretched tight. As a result, one would normally expect a rebound in the opposite direction to relieve the tension. But so far that has not occurred.

The first of the lower indicators is a moving average convergence divergence (MACD). While it is not yet at a level that could be considered extreme, it is certainly at a level where there would normally be likelihood for a correction.

The bottom portion is a stochastic oscillator. This tool is designed to help identify cycles within what appear to be random market movements. When the oscillator nears 80 it indicates that the investment is overbought and a downturn is likely. When it approaches 20 the investment is considered oversold and an upward rebound usually ensues.

This health care fund climbed above 80 in mid-February. While the oscillator then corrected, it only completed a half cycle before turning back up. Since early March, it has continued to hover at an overbought level. When this type of pattern occurs, it is normally a sign of a strong bull trend.

I added the green arrows to show that there was a similar situation with this fund (and many other health care positions) at the end of 2009. Although it was at an overbought level, it continued to advance strongly even though technical indicators were giving readings that traditionally produce corrections.

The debate over health care reform is going to continue for years. There will no doubt be many changes to any legislation passed by Congress. In the meantime, it is going to be business as usual for the health care industry and health care funds.

Strategis Financial Group is currently holding a position in a health care fund, Fidelity Select Medical Equipment (FSMEX), in its Foundation Strategy portfolio.

F.S.

For the past year, one of the stronger market sectors has been real estate. That might surprise some investors since troubles in the real estate market were directly responsible for much of the world’s current economic turmoil. Over the short term, real estate funds could continue to offer profit opportunities but investors need to use caution because the longer-term outlook for real estate remains murky.

One of the larger banks in our region of the country is Zions Bank. In a recent newsletter for bank customers, there was an article that addressed the question of whether or not this is a good time to invest in real estate.

I’m including some excerpts from that article below. The author is writing about buying and selling actual property and not real estate funds. But if his insights are accurate, the real estate sector will feel the impact over time. Keep in mind that this is a bank that does mortgage loans in an area of the country where the economy has stayed comparatively strong.

“Nationally, real estate prices still have not reached bottom. And when they do hit bottom, they are likely to stay there for quite a while. There is no rush to get into real estate unless you find a house that you want to live in or hold onto for years. This is not the time to make money speculating.

“The problem is that there are too many houses for sale, and this will not change for some time. … The driver of excess supply is foreclosures on existing homes.

“Contrary to what you might expect, these foreclosures are not being driven primarily by unemployment caused by the recession. During the boom, many people bought new houses at inflated prices and took on big mortgages. Now, a lot of borrowers have mortgages that are much larger than the value of their homes.

“About 25 percent of all home loans today fit this category. Expectations are that this percentage will rise to perhaps 45 percent or more by 2011! For the first time in U.S. history, borrowers who are perfectly capable of paying mortgages are abandoning homes and handing in the keys. It is a rational economic decision, but it will keep foreclosures and distressed sales coming for two or three more years. Residential real estate will not fully recover until we are beyond that period.

“The same thing is happening in commercial real estate, where similar price inflation occurred between 2004 and 2007. Many commercial properties, even ones that are fully occupied with paying renters, are worth less than the size of the loans taken out to buy them. The problem with commercial real estate developed later than it did with residential real estate, so we can expect an increasing number of distressed sales of every type of commercial property for the next several years.

“The issue with investing in real estate now is that you might need to hold on to the property for many years before seeing its value return to what it was a couple of years ago. Property seems cheap now because we’re comparing it to the inflated values of 2007. If you had to hold on to it for 10 years waiting for its value to reach 2007 levels, your rate of return would likely be inferior to what you might have realized by investing in a different type of asset.

“If you still want to invest in real estate, wait a couple of years for real bargains.”

If you know people in the banking, mortgage, or real estate industries—or if you follow the financial news media—you are probably aware that banks are currently tight fisted when it comes to lending money for home purchases.  If the general perception among bankers is that the housing market has yet to bottom, being stingy with real estate loans makes sense. If a bank puts up an 85% loan on a home and the value of the home drops an additional 20% then the bank itself is underwater on the loan if the homeowner defaults.

The accompanying chart shows a comparison between iShares Real Estate (IYR) and the S&P 500 Index over the past four years. Notice that IYR peaked in February 2007, a full eight months before the S&P 500 topped out. The ensuing decline in this real estate ETF was also significantly greater than the decline in the S&P 500.

As long as the current market rally continues, real estate is likely to remain among the leading sectors and the technical picture for IYR is currently positive. So over the short term, some profit opportunities might still be available in real estate. But anyone investing in the real estate sector needs to do so with caution and an awareness of the longer-term risk levels.

Over the past six months, major stock indices have moved upward but it has not been a smooth ride for investors. Most of these indices peaked in early January and then retreated fairly sharply. Since bottoming in early February, most of these indices have recovered most of the ground they gave up.

The accompanying chart shows the six-month performance of four major indices: the New York Stock Exchange Composite (NYSE), the Nasdaq, the Dow Jones Industrials Average (DJIA), and the S&P 500.

Since the February bottom, the Nasdaq has been the strongest of this group. So far it is the only one of the four that has exceeded its most recent January high. The broadest index, the NYSE, is still under water for the year but it has rallied strongly from its recent February low.

For investors who have been in the market during this period, it might not feel like much of a rally. After all, at their February lows, these four indices had generally sacrificed the gains they accumulated during the previous four months.

As I wrote last week, however, most technical indicators for stocks are now positive. And in spite of the pullback in January and February, the uptrend that began in March 2009 is still intact.

The second chart shows the typical phases of a secular bear market—the type of market numerous economists and analysts believe we are currently experiencing. I added a red arrow that points to the spot of the cycle that we believe likely corresponds to our current position.

Many investors right now are wondering if the best course of action over the next couple of years might be to move the bulk of their assets to the protection of a certificate of deposit (CD). It is a fair question.

First it is important to understand that while the pattern shown by this chart might be typical for the bear market studied, there is no guarantee that in this instance the market will follow this pattern.

While we think we are currently in the rebound rally area, it is possible that the market has already moved into a sideways trading range. Or the rebound rally might persist for several more months.

If things progress in a typical fashion there should be another correction soon followed by a prolonged trading range. While the trading-range period is an overall sideways pattern, we believe an active management system can capture profits during such periods. Of course investing carries no guarantees and past performance is no indicator of future success.

Unfortunately, all bear markets do not follow a fixed pattern. The trading range could begin tomorrow. The next down-leg of the correction could begin next week. There are no guarantees. But over the next several years, we believe our market tools will enable us to capture a greater return than by simply remaining in a money market or a CD.

Right now CD rates are quite low by historical standards. Many economists believe that an increased inflation rate is inevitable in the near future. Rising inflation will erode the value of today’s current rates. And rising inflation means that interest rates will likely be higher in the future. As a result, we believe this is not a good time to lock in low long-term rates.
F.S.

Over the past three weeks, the equity markets have improved their positions and most technical indicators are positive again. The big question is whether or not this advance will continue or stall.

While there are still lots of negative economic fundamentals, recent days have also provided some positive reports. For example, the Labor Department Thursday reported that initial claims for unemployment insurance fell by 29,000 to a seasonally adjusted 469,000. While it is still a dismal number, at least it moved in the right direction this week. Also, the Commerce Department reported that retail sales rose in February by the largest amount since November 2007. Last week’s blog explained why the role of consumer spending is so important to economic recovery.

The chart below shows the performance of the S&P 500 Index over the past year. The gold line is a 50-day simple moving average (MA) of the index. The most recent correction sent the S&P 500 below the MA in mid-January. Over the past week, the index made a tentative move back above its MA.

One of the most basic indicators of an investment’s strength and momentum is whether it can trend above its 50-day MA. For most of the past year, the S&P 500 was easily able to do that. Right now it is barely above that mark. If it can move decisively above over the next week or two that should be viewed as a positive sign that the index can challenge its December 2009 highs.

The middle portion of the chart is a moving average convergence divergence (MACD). It turned upward a couple of weeks ago and is now right at the zero mark. The recent momentum is clearly upward. The slope of the MACD on this upward move is not nearly as steep as the moves we saw in March 2009 and July 2009. It is more comparable to the move of November 2009. That move produced several weeks of sideways consolidation before the S&P gained ground in December. It would not be surprising to see some consolidation at the current juncture.

The bottom portion of the chart is a stochastic oscillator. It is currently above 80 and rolling over. That is an overbought level and would normally indicate that some consolidation or correction is likely to follow.

The next few weeks are going to be important in helping us understand the near-term nature of major stock indices. If the indices can exceed their 2009 highs, then the bull rally of 2009 is likely to gain strength and continue moving upward. If the rally falters and the old high is not broken, then stocks could begin another bear phase.
F.S.