Coming into 2015, Healthcare was one of the sectors that we wanted to focus on from the long side. From a relative strength perspective, there was nothing out there that we could even compare it to. Healthcare was by far the strongest sector across U.S. markets. Our upside targets were hit on March 20th. I remember that day vividly because it was a Friday and our upside target in Russell2000 was hit on the exact same day.
Here is a daily candlestick chart of the S&P Healthcare Index ETF $XLV showing why 75 was our upside target coming into the year. Members of EagleBaySolutions receive updates on this research several times a month. First of all, the last major correction we saw in healthcare was during the September/October decline where most of the U.S. equities market took a hit. That correction has been a great reference point for a lot of sectors and averages, not just healthcare. But today, we’re focused on the $XLV. $75 and change was exactly the 261.8% Fibonacci extension of that decline. But in addition, it was also the 4 point measured move target based on the consolidation from December through February before the breakout:
Once that upside objective was achieved, we saw no reason to be involved in this sector any longer. Fortunately we went no where over the next several months as the market, as usual, reacts and respects levels where Fibonacci and measured move targets cluster together. There is a reason why we watch these levels and set target prices.
Since last month, however, healthcare once again tried to break out and make another move higher. The problem is that momentum never confirmed it. Notice how on these new highs, momentum has been putting in lower highs. This is what we refer to as a bearish divergence. Prices have since then failed to hold those highs. We love that. A failed breakout and bearish momentum divergence is a great combination. Here is the 14-day RSI, which is our momentum measure of preference, already putting in a bearish divergence when our upside target was hit in March. Notice how on the recent breakout attempt, RSI didn’t even reach overbought conditions. This is a bearish characteristic:
As far as relative strength goes, remember this was one of the reasons we liked it in the first place coming into 2015. Here is a $XLV relative to the S&P500 breaking an uptrend line from the past few months and momentum also putting in a bearish divergence. It’s the combination of bearish momentum divergences on multiple timesframes and relative strength that really catches my attention (also see: Is Apple About to Crash September 2012).
The weekly timeframe is also showing this bearish divergence. As well as healthcare has done over the past few years, momentum has yet to confirm. Looking bigger picture and taking the weight of the evidence, this adds to the bearish thesis:
I don’t know what is going to happen in healthcare. No one does. I don’t claim to know something that others don’t. I’m simply asking the question: Is this the beginning of a severe correction for America’s most loved sector? You tell me. The weight of the evidence suggests to me that a short entry could be here. Our upside target in March was just over $75. I don’t see any reason to be short if prices are above that level. This makes the risk/reward very much skewed in favor of the bears and the risk is well-defined. To me, that’s what matters most.
Price target-wise, where do I think we’re headed? $62-$64 in $XLV looks like a good area to take profits on shorts. This is the level where we broke out from in late October before healthcare made it’s (potentially) final run. This area is also where several Fibonacci levels cluster together, particularly the 261.8% extension of the entire 2007-2009 correction and the 38.2% retracement of the 2012-2015 rally. To me it’s where support/resistance levels and Fibonacci all come together. I would be covering shorts down there. This represents 14-18% lower from current prices.
I’m throwing ideas out there that I think make sense. That’s all this is. Some of the top holdings in the Healthcare space $JNJ $GILD $PFE $MRK are all showing similar characteristics. So I don’t believe that this is out of left field. What do you guys think?
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Tags: $XLV $SPY