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PPH article

 
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arthur
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PostPosted: Sun Oct 24, 2004 8:27 am    Post subject: PPH article Reply with quote

Pharma could get a Merck rebound
Commentary: Savvy investors see an opportunity

By David Nassar
Last Update: 11:42 AM ET Oct. 5, 2004
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Editor's note: David Nassar is chairman and chief executive of MarketWise.com.

BOULDER, Colo. (CBS.MW) -- Following the complete withdrawal of Merck's popular arthritis treatment drug, Vioxx, shares of this bellwether pharmaceutical company plunged last Thursday, losing roughly $25 billion in market capitalization (27 percent of its value) and taking the Pharmaceutical Holders Index lower as well.

With the volume crescendo and negative fundamental news clearly seen within shares of Merck (MRK: news, chart, profile), the Vioxx event may have been the catalyst that flushed out weak holders of shares in this sector.

Savvy investors will want to look for these very opportunities, buying strong companies within the PPH (PPH: news, chart, profile), or to begin overweighting this sector by scaling into the PPH Exchange Traded Fund, or ETF.

This highly-watched ETF indicated a technically "oversold" level of $73.30, prior to the Vioxx news, but this 'nail-in-the-coffin' may just be what is needed to begin looking for the bullish reversal. The bullish confirmation will come once the PPH can close and remain above last Thursday's high of $72.45, thus giving buyers a reason to get involved on strength.

The PPH has much to gain from both the technical and fundamental viewpoint, a rare "aligning of the stars" that can open a window of opportunity for the mid-term investor with an investment horizon of six months to a year. As capitulation meets confidence, the pharmaceutical sector at current levels allows for good reward potential relative to risk. It may seem unnatural to buy capitulation, but that is exactly what one should do, especially when fundamentals also support the technical landscape. Fearful selling is almost always a typical emotional knee-jerk reaction, already known to Wall Street.

Think of news dissemination like a food chain, where the general public generally lives near the bottom. Most news is digested in price, meaning that professionals higher up the chain are probably already out. Follow-through selling generally reflects the amateur, lower-in-the-chain and acting on emotion, hence the reason one should buy capitulation. This theory and practice will serve you better when trading an index or sector as opposed to an individual stock, since more stock specific news will likely follow -- adding additional pressure to Merck and other stocks in similar jarring situations.

As fundamentals improve with an overall healthy post election market, the PPH stands poised to rally strong. While shares of Merck, a Dow component, will not serve as a buying candidate in my estimation, we could say that this heavily traded issue took one for the "team' (the pharmaceutical index) and inspired to accelerate the capitulation. Merck's weakness raises the question to the entire index, not immune to the same risks -- "what if other drugs have a similar fate"?

While Vioxx has all the fundamental and empirical data to support its dark fate, Wall Street's "what if" question simply isn't enough justification for the recent sell-off in the group. This may be a case of "the baby being thrown out with the bathwater."

While the Food and Drug Administration (FDA) inquires always keep the group on its toes, the Vioxx withdrawal will likely play out well for the component issues of the sector such as Pfizer (PFE: news, chart, profile) which produces a rival arthritis drug, Celebrex.

Other strong stocks within the PPH include Abbott Labs (ABT: news, chart, profile), Johnson &Johnson (JNJ: news, chart, profile), and Wyeth (WYE: news, chart, profile). Any confidence seen within these aforementioned companies explain to the market that companies with solid earnings growth potential will be well rewarded on the street. Merck, on the other hand, has a strong propensity to follow through and trade lower given the lasting effects of a worldwide recall of a blockbuster drug -- not to mention potential litigation.

Specific performance within the sector and the component leaders also tells a story behind the numbers, given Merck was the only issue without double digit year over year growth (9 percent). Pfizer, leading the PPH both in index weighting (26 percent) and year-over-year growth of 24 percent; JNJ with 17 percent weight and 11 percent growth; ABT with 7.5 percent weight and 14 percent growth; and WYE with almost 6 percent weight and nearly 13 percent growth. Given these fundamentals, coupled with the technically oversold condition, the reversal potential appears justified.

Technically, the PPH has been under pressure all year and is nearing its 2003 low of $67.55, which was also a level of support in late 2002. If the weak holders have truly been washed out of the stock with Merck's news, a revisit of that low is unlikely.

Confirmation of strength would instead exist at the $72 level, representing not only an area of support in early July but also numerous times in late 2003.

Note: In last week's issue, I covered the potential for a rally in the Cyclical Index (CYC: news, chart, profile), as well as shares of Phelps Dodge (PD: news, chart, profile) and Southern Peru Copper (PCU: news, chart, profile). With the Cyclical Index up 2.7 percent, Phelps Dodge up 1.6 percent and Southern Peru Copper up 7 percent since our article, traders should once again be reminded about taking a contrarian's approach to downgrades -- especially heading into the earnings session.
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