Investors need to pay attention to biotech and healthcare stocks this year. Predominantly the charts of sector tickers like the Health Care Select Sector SPDR Fund (NYSEARCA:XLV), the SPDR S&P Biotech ETF (NYSEARCA:XBI) and United Healthcare (NYSE:UNH) look bullish from a technical perspective. This is despite worries over political shenanigans that usually surface going into an election season.
Healthcare and biotech stocks tend to come under fire from both the Democrat and the Republican parties. Nevertheless, this time the stocks within the sector are resilient. And there is evidence that they are on the verge of a breakout.
This speaks to the innovation within the sector, as well as the need for its services, especially during fears stemming from the coronavirus from China. Today, we focus on three ways to bet on the sector, two of which are general nets cast over the whole thing. In addition, we examine why UNH stock could continue setting new highs, even from these altitudes.
We also have to recognize that the stock markets in general are very high. This morning’s sharp market drop relinquishes 80% of the recent froth from the February rally. The bulls are still in charge, but today is proof that it won’t take much to spook them. Consensus is that we have come so far, so fast that investors have one foot out the door. That alone is not a reason to short, but it doesn’t hurt to be extra cautious when chasing upside in such environments.
Healthcare Stocks to Buy: Healthcare Select Sector SPDR Fund (XLV)
The easiest way to bet on a sector is to trade its most popular exchange-traded fund. Although it’s not technically a stock itself, the XLV allows investors to trade numerous healthcare stocks without needing to research each one. These are complex companies and becoming an expert in them is a full time job. Most of us don’t have the kind of time it requires to dissect them all. But with a little bit of homework on equity markets and an understanding of where the healthcare sector sits within them, investors can relatively easily develop a thesis and establish a sound position in healthcare.
The immediate pivot below current levels is near $99 per share. That’s the short-term dip to buy. There are two longer-term major pivots at $92 and $81. The first was the October breakout of 2019, which brought a rally that is still ongoing. The second was the awful crash of 2018, when the whole market fell on extremely bearish sentiment. So investing in new positions of XLV here requires trusting that the momentum will sustain through the next two important news weeks. The alternative would be to wait out a few ticks and see if the market bulls decide to buy the dip in XLV.
An entry closer to the $92 pivot would constitute a correction from high to low. But depending on your investing time frame, there is danger for the correction — if and when it happens — to extend another $10 lower and hit the second pivot levels noted. This means patience is the best course of action in picking new entry points. The idea is to either chase XLV into a new all-time high. Or wait out the earlier part of this week to see where overall risk appetite stands. At worst, it is best to only take partial positions, so that one can add to them on deeper corrections.
The SPDR S&P Biotech ETF (XBI)
The XBI ETF offers a biotech variation to the XLV trade, and it has two key advantages.
The first is structural because its weight is distributed in small increments under 2% among each of its components. This lessens the possibility of a disaster in one of its stocks dragging the whole ETF down. The XLV, on the other hand, has Johnson and Johnson (NYSE:JNJ), United Health (NYSE:UNH), Merck (NYSE:MRK) and Pfizer (NYSE:PFE), which constitute 11%, 7%, 6% and 5% of its allocation, respectively.
The second advantage has more to do with timing than ETF structure. Currently the weekly XBI chart is not as extended as the XLV. The XBI has a long period of consolidation just below a hard resistance line. This raises the odds of a snap breakout from it once it happens. The opportunity lurking is just above $99 per share. If the bulls can do it, they can add another $20 or more from that point. It’s usually best to wait for the breakout confirmation at the risk of missing the first few bucks. But for some, it’s worth it to jump the gun and get in early in anticipation of the move. But in that case, it’s ideal to enter the position in tranches — not all at once.
For the bulls to take risks, they need to know there is support below them. The XBI ETF has its first support zone near $88 per share. If it fails, there is a stronger secondary one just $5 lower. In the worst case scenario, there is also the support from the October breakout base near $75 per share. Meanwhile, there is nothing imminent in the XBI chart without a market-wide correction. If the whole market falls, it will also come under fire. However, the chart is bullish. The buyers are in control and setting higher lows attacking a neckline with force. If the line fails, the bulls will prevail and overshoot into a nice breakout.
United Health (UNH)
United Health stock has found solid support around its $215 base. The last three times it fell into it, the stock rallied 30% to 45%. This floor was set after the October 2017 pivot and that was the good news then. The bad news was that after the strong rally to $290 per share, the bears took their revenge with a very harsh correction. So while there is no evidence or reason to immediately short this rally here, there is also no rush to chase it.
The next opportunity in UNH stock is to buy it on the dip. The risk is to miss out on a few upside bucks. But the weekly stock range has been expanding and the risk of a pull back is real. Therefore, prudence is the better course of action here. There are still bullish signs and the buyers are in control. The stock is still setting higher highs, but also lower lows. The breach of either sides of the range will have momentum in that direction. So for the mid-term, the bullish trade on UNH is to chase the breakout into a new high. If that happens, the bulls will overshoot toward $350 per share.
Conversely, the first important support to hold is near $269 per share. This would represent a 9% dip and an opportunity to trade UNH for the bounce. If the bears are able to break below it then the risk is another $10 lower from there. Below $250, there is too much support and it would make for an excellent entry point for new positions and additions to current ones. United Health is a cheap stock with a forward price-to-earnings ratio of 18X. It trades at only 1.2X its sales. There isn’t a lot of fat to trim if bad times hit it.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. Join his live chat room for free here.
