John Murphy: Sector Favorites

09/24/2004 12:00 am EST

Focus:

John Murphy

Head Market Analyst, Stockcharts.com

"I believe that the best way to find winning stocks is to first find the winning sector," says John Murphy, chief technical analyst at StockCharts.com and one of the finest technicians around. Here, he looks at some ways to play the market’s recent winning sectors.

"The first step in trading relative strength is to isolate a group that's starting to outperform the market. Biotechs certainly qualify. The AMEX Biotechnology Index has broken through its summer highs to reach the highest level in five months. A second step is to find biotech stocks that are showing good chart action and their own relative strength leadership. Two candidates are Biogen IDEC (BIIB NASDAQ) and Millennium Pharmaceuticals (MLNM NASDAQ). Biogen is trading well above its moving average lines and has been showing good relative strength since late July. It's also one of the biggest stocks in the group. Millennium is also showing good relative strength although its ratio line didn't bottom until mid-August. If you want to buy strength, BIIB may be the better choice. If you're looking for a cheaper stock, MLNM may be better. There are two other biotech stocks that look even stronger. Gilead Sciences (GILD NASDAQ) has hit a new 52-week high and the stock appears to be breaking through its 2003 to a new record high. That puts this leader on a buyer's biotech shopping list. If GILD appears to high, there's another biotech candidate that looks a lot cheaper Human Genome Sciences (HGSI NASDAQ). I'm always looking for important chart developments and this is one. The daily chart of HGSI shows the stock having just broken through its 200-day moving average and hitting a four-month high. The short and long-term chart pictures certainly qualify HGSI as a potential buying candidate.

"The problem with buying individual stocks in a rising sector is that there's no guarantee you'll wind up with the actual leaders. A simpler way to participate in a group rally is to buy the whole group. There are two ways to do that. One is by buying biotech exchange traded funds (or ETFs). These are baskets of stocks that trade like individual stocks on the American Stock Exchange. By using an ETF, you can buy one stock and get a piece of the entire group. We would point to two biotech ETFsMerrill Lynch Biotech Holders (BBH ASE) and iShares Biotechnology (IBB ASE). Another way to buy into the biotech sector is through a mutual fund. Two such sector funds are the Fidelity Select Biotechnology (FBIOX) and the RYDEX Biotechnology Fund (RYCFX). Although the Fidelity fund is the first to clear its 200-day line, the RYDEX fund is the first to break its down trendline. Both, however, show the potential for emerging as market leaders."

"One of the standout groups recently has been consumer discretionary stocks. The AMEX Consumer Discretionary Select SPDR (XLY ASE) recently hit a new three-month high on big volume. Its relative strength ratio line has been rising since mid-August, which shows new money flowing into this sector. One of the driving factors in this group may be the continuing drop in long-term interest rates, which is good for consumer spending. One way to take advantage of that trend is to buy the exchange traded fund. Another way is to look at some of the leading stocks in the fund. The best performing stock in the group recently has been Best Buy (BBY NYSE). The daily chart shows the stock surging on rising volume and breaking through its 200-day average. Its relative strength ratio line is rising sharply as well. Although it looks over-extended on a short-term basis, its longer term prospects look promising. The weekly chart shows the stock having broken a major down trendline starting from last November. The weekly volume bars show heavy upside trading over the last three weeks. And, the weekly MACD lines have turned bullish for the first time this year. Bed Bath & Beyond (BBBY NASDAQ) is another potential leader in the consumer discretionary group. BBBY started to show new relative strength toward the end of August. Its relative strength ratio line is now climbing, which means the stock is outperforming. Even better is the ability of the stock to close over its 200-day moving average for the first time since April. That's a good combination. BBBY qualifies as a buying candidate in a group that's starting to attract new money.

"The Industrials Select Sector SPDR (XLI ASE) are hitting a new recovery high and moving closer to its summer high. Its relative strength line has been flat during the summer, but is starting to rise. If the stock market rally continues at least to year-end (as I believe it will) the XLI should be one of the first sector ETFs to breakout to the upside. If an investor doesn't like the ETF, he or she can look at one of the bigger sector stocks like General Electric (GE NYSE). Generals are supposed to lead and this one is. And that's important. Not only is General Electric considered to a bellwether for the NYSE, but it's the most heavily-weighted stock in the Industrial ETF, accounting for 20%. As of this writing, GE is within a point of its early 2004 peak. That will be an important test for the stock, the industrial sector, and the entire market. A close in new high ground (which appears likely) would be bullish for all three. The monthly chart of GE dispels the idea that the stock is ‘too high’. After peaking in the high 50s three years ago, the stock has retraced only a third of that bear trend. A 50% retracement of the previous bear trend would put the stock at 40, and a 62% retracement would carry the stock to 45. GE is now outperforming the S&P 500 for the first time in three years. That bodes well for the market and the industrial sector."

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