Health Care Stocks’ Breakdown Could Result In A Fast Drop

Health care is one investment theme that’s certainly in vogue right now. While traditionally considered a defensive sector, I’ve heard numerous pundits declare its classification has changed from defensive to growth. 

I always find it interesting when people change their long-held assumptions about the market. Think about what happened when traders began to substitute “eyeballs” for “earnings” in the P/E ratio during the dot-com bubble, for example. Eventually, the market usually reminds them who’s boss. 

Health care has been leading the market for many months, with the Health Care Select Sector SPDR ETF (NYSE: XLV) posting an 8% gain year to date as the broader market has moved sideways. Plus, the relative performance charts of most health care indexes versus the S&P 500 continue to point higher. 

So, at first glance, it seems like there is not much to dislike. But the sector is overbought, and one event that can act as a double-edged sword in any sector is merger activity.

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Mergers can boost share prices thanks to operating synergies between the companies involved. They can also signal that executives feel their stock is so valuable — perhaps overvalued — that they use it as a currency to buy rivals.

While we cannot know what is in the minds of CEOs, we can look at the charts to see what the market is doing about it all. And right now, the proposed deal between health insurers Anthem (NYSE: ANTM) and Cigna (NYSE: CI) is not sitting well. 

Last month, Anthem offered to buy Cigna. Predictably, shares of the latter shot dramatically higher, but Cigna rejected the bid. Meanwhile, the market was looking for a higher bid and the stock continued to climb. However, Cigna has since given back a chunk of those gains. But considering this coincided with the broader market’s recent weakness, it wasn’t too terrible for the stock from a technical perspective.

We cannot say the same for Anthem. 

Anthem also rallied after the takeover bid before falling a bit with the market. Shareholders’ initial excitement faded, likely because Anthem would have to raise its offer if it decided to move forward with the deal.

But here is where the problem really manifests for ANTM. The July decline confirmed a bearish momentum condition — falling Relative Strength Index (RSI) with rising prices. It also broke an intermediate-term trendline from October and the 50-day moving average to the downside. The bloom is apparently off the rose.

ANTM Stock

Again, with so many analysts changing their tune to health care as a growth sector, sentiment has gotten at least anecdotally frothy. Everyone seems to be on the health care bandwagon, and that sets stocks in the sector up for disappointment. As a result, any weakness in fundamentals, problems in the market or even a single earnings miss could send the entire sector lower

The lack of new buyers, since most folks have theoretically bought to create the sentiment condition, leaves a vacuum of demand. Weak bulls can start a stampede lower.

I am not forecasting a major decline, but it does seem this sector, and especially Anthem, are in need of a good cleansing. A correction down to the long-term trendline from 2012 and 200-day moving average currently in the low $140 range would be a welcome refresher.

Smart investors will keep an eye out and capitalize on the buying opportunity in the event of the sector’s likely decline considering the general growth consensus surrounding health care. But the savviest investors will also profit as it gets down there by shorting ANTM.

Recommended Trade Setup:
— Sell ANTM short at the market price
— Set stop-loss at $165
— Set initial price target at $142 for a potential 6% gain in four weeks

Note: In addition to the technical breakdown on the chart, an event is scheduled to take place at the end of this month that could result in even bigger losses for ANTM. A market expert who foresaw both the dot-com bust and the 2008 financial collapse is predicting hundreds of popular stocks may fall 10% to 30% in the coming days and weeks. He has put together a presentation to help you prepare and potentially profit from their collapse. Click here to access it now.

This article was originally published on ProfitableTrading.com: Health Care Stock’s Breakdown Could Result in a Fast Drop‚Äč