Health care sector overbought but advancing
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.