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Are Health-Care Stocks Overbought?


Why the Senate shake-up might not drive the sector higher after all.

The Senate shake-up has investors convinced that health care is a money-making investment opportunity.

In Massachusetts yesterday, Republican candidate Scott Brown secured 52% of the vote for the seat that Democrat Ted Kennedy held for more than four decades. He's now on his way to Washington, where he'll work as the 41st Republican Senator.

This is an especially impressive victory, strategists note, seeing as how the people of Massachusetts haven't elected a Republican senator since 1972. Barack Obama won the state with 62% of the votes in the presidential election.

Dr. Ed Yardeni of Yardeni Research described Brown's victory as a huge upset and a major reversal of fortune for the Democrats and their political agenda.

"I think it is safe to bet that their plans for health care, cap-and-trade, and card-check were buried by the Massachusetts landslide," the investment strategist wrote to clients this morning.

Then again, as Yardeni quickly points out, it's still an open question as to how the Democrats will play this surprising defeat.

Regardless of this upset -- which of course follows losses in New Jersey and Virginia -- will the Democrats still try and punch through the hotly contested health-care legislation?

"It would be political suicide, but who knows what Kool-Aid Nancy Pelosi and Harry Reid are drinking?" asks Yardeni.

Dennis Gartman of The Gartman Letter raises a similar question, noting some tough talk that Democrats would attempt to keep Mr. Brown from taking office in speedy fashion, he writes, in order to give the House and the Senate time to pass a health-care bill.

But Gartman doesn't buy it. "The Democratic leadership in the Congress may be left-of-centre and wrong on most issues but it is not mendacious; it is not stupid and it is not self-destructive," he says.

For their part, investors placed their bets and decided that Brown's win meant the pending health-care reform is in jeopardy. Gridlock now might rule the day inside the Beltway.

Yesterday, health care was the top performer, as the Health Care SPDR (XLV), which includes holdings like Abbott Laboratories (ABT), Gilead Sciences (GILD), Medtronic (MDT), and Merck (MRK), jumped 2.4%. The XLV is up 13% since the House passed PelosiCare on November 7, emphasizes Yardeni.

(As we write here in the late morning, the ETF has slipped 1.2%).

Other big winners yesterday: Humana (HUM) and Coventry Health Care (CVH) surged 7.1% and 6%, respectively. Eli Lilly (LLY) rocketed up 4.4% while Forest Laboratories (FRX) climbed 3.6%.

The reason for all this capital commitment to the sector?

Simple, says Jon Markman of Markman Capital Insight: "…health-care stocks bolted higher on the prospect of less government intervention, fewer cuts to Medicare payments, fewer curbs to drug prices and the elimination of a requirement for businesses of a certain size to provide health insurance to employees."

Here at Minyanville, over these last few months, we've chatted with a number of talented professional stock pickers that have placed contrarian bets on health care, believing that, despite the barking out of our nation's capitol, this sector was still a good investment.

Last September, Joe Milano, the 37-year-old manager of the T. Rowe Price New America Growth Fund (PRWAX), told us why he liked the space in our article, Lessons From the Large Caps.

And, this week, Bruce Berkowitz of Fairholme (FAIRX) elaborated on why he's a fan of drug companies like Pfizer (PFE) for our story, How to Pick Stocks by Ignoring the Herd.

However, although specific companies like Forest Laboratories and Bristol-Myers Squibb (BMY) look very strong here, Markman argues that the health-care sector as a whole has now reached very overbought levels and, in his opinion, investors should tread carefully.

The market pro points out that the XLV hasn't been this extended on a weekly basis since early 2004. Back then, he writes, a 15% correction lasting nine months followed before the upswing resumed.

There's an important similarity between early 2004 and today, says Markman.

"Back then, it was about six months before the Federal Reserve started to raise interest rates," he wrote. "Although its official 'policy' rate will likely remain on hold throughout 2010, the Fed will start likely unwinding its extraordinary direct debt purchase tools in as little as six weeks."

In a recent chat we had with Markman for The Case for a Correction, he made it clear that he forecasts a period of near-term weakness as the S&P 500's 10-month moving average plays catch-up with the underlying index.

It's a view that he's maintaining: "[T]he measures of internal market strength that I monitor suggest we're witnessing a topping pattern rather than the beginning of a fresh uptrend," he argues.

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