Volume and relative performance analysis suggests that two big drug stocks and a primary health care sector ETF are likely to outperform through the typically defensive summer months.

Overseas markets appear to have survived the holiday weekend, and despite a choppy European session on Monday, markets were higher early Tuesday. The first few months of 2012 were characterized by initial disbelief in the stock market’s strength, followed then by a level of optimism in March and early April that enticed many into stocks at just the wrong time.

While the negative market sentiment has not yet reached levels generally associated with significant market bottoms, the sharp decline in Treasury yields indicates where investors are placing new money. The fiasco over the Facebook (FB) IPO has also done little to inspire investor confidence.

Though the Spyder Trust (SPY) is down almost 4% over the past three months, the Select Sector SPDR - Health Care (XLV) is actually up slightly during that same period. As I discussed here last Friday, it is my view that the current decline will provide a good opportunity to buy those stocks that have attractive yields and are outperforming the overall market.

These two drug stocks as well as one of the leading health care sector ETFs should be purchased over the next week or two as the market corrects to more important support.

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Chart Analysis: The Select Sector SPDR - Health Care (XLV) made a new high at $38 in early April and had a low of $35.81 last week. The weekly uptrend, line a, and the lower Starc band (Starc-), are in the $34.80-$35.20 area.

  • The 38.2% Fibonacci retracement support from the October 2011 lows is at $34.99 with the 50% support at $34.06
  • Over the past few weeks, the relative performance, or RS analysis, has surged back above its downtrend, line b. It is also above its rising weighted moving average (WMA)
  • Weekly on-balance volume (OBV) has been above its weighted moving average since last October
  • Near-term resistance is now at $36.60-$37.20

Abbott Laboratories (ABT) is a $96 billion drug manufacturer whose stock currently yields 3.3%. Abbott is scheduled to be broken into two companies by the end of 2012. The stock price is up 8.4% since the start of March. In early May, ABT had a high of $63.20.

  • The daily chart shows that the resistance from 2008, line c, was overcome at the end of March
  • Completion of the weekly trading range has long-term targets in the $73-$75 area
  • Weekly RS analysis has moved through two-year resistance, which completes a significant bottom formation
  • The weekly OBV surged through strong resistance, line e, in late 2011
  • OBV tested its rising WMA early in 2012 and is well above long-term support at line f
  • The $58.50-$61 area and the rising 20-week exponential moving average (EMA) now represents first support
  • There is additional support now in the $55.80-$57 area

NEXT: Another Big Drug Stock to Buy on a Correction

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Eli Lilly and Co (LLY) is a $45.9 billion drug manufacturer whose stock currently yields 4.8%. The weekly chart shows that LLY had a high of $42.03 on the first day of trading this year.

  • The correction from the year’s early highs found support in the $38-$38.30 area, which now corresponds to the weekly uptrend, line b
  • Weekly RS line moved above its weighted moving average at the end of April and is still rising strongly
  • Weekly OBV is back above its rising weighted moving average but is still locked in a trading range, lines c and d
  • A weekly close above $41.50 would overcome the trend line resistance at line a

The daily chart of Eli Lilly and Co (LLY) shows that it has formed a flag formation, lines e and f.

  • On a close above line e, the width of the trading range has upside targets in the $44.50-$45 area
  • The daily RS analysis completed its bottom formation in April when it moved through resistance at line g. It is still clearly in an uptrend and well above its rising weighted moving average
  • There was a huge volume spike in late April during which the OBV had risen sharply. It now shows a strong uptrend, line h
  • There is now short-term support at $40.40 and stronger support in the $39.50-$39.80 area

What It Means: If stocks can rally back to stronger resistance this week, it should then be followed by another wave of selling that will take the major market averages back to and likely below the lows from May 18. This decline should be a good buying opportunity.

The Select Sector SPDR - Health Care (XLV) and these two drug stocks look attractive for new purchases, as their volume and relative performance analysis suggests they will do well during the summer months.

How to Profit: For the Select Sector SPDR - Health Care (XLV), go 50% long at $36.04 and 50% long at $35.28 with a stop at $33.83 (risk of approx. 5%).

For Abbott Laboratories (ABT), go 50% long at $61.14 and 50% long at $60.22 with a stop at $57.28 (risk of approx. 5.6%).

For Eli Lilly and Co (LLY), go 50% long at $40.52 and 50% long at $39.70 with a stop at $37.48 (risk of approx. 6.5%).