Big Pharma... From Bad to Less Bad

It's time to buy Big Pharma.

I can almost hear the collective groans. And, in the words of a former United States President, "I feel your pain."

It is more than just a little ironic that in an industry where the primary products are supposed to ease pain and suffering, shareholders have endured such tremendous agony.

Indeed, large-cap pharmaceutical stocks make up one of the worst performing market sectors over the past three years. Of course, that's to be expected when big names like Merck and Pfizer drop 40% and 33%, respectively. And, when even a stalwart stock like Johnson & Johnson can only put up a paltry 10% gain since this cyclical bull market began, then you know it's been a difficult three years.

But that's all about to change...

The recent performance of large cap pharmaceutical stocks is hinting at a new bullish Big Trend to get underway. And the last time this sector was poised as it is now it generated triple digit gains in just two years.

Suddenly, I don't hear the groaning anymore...

My friend Steve Sjuggerud often points out that the largest profits occur as the conditions surrounding a stock or industry move from bad to less bad. Not only do I agree with this concept, but history also proves it correct.

That's why it's so important to pay attention to the news flow surrounding a stock or an industry, and even more importantly, the market's reaction to that news flow. One of the surest ways to recognize that a stock is ready to change trend, from bearish to bullish or vice versa, is to note how that stock reacts to news.

For example, when a stock no longer reacts favorably to good news, that lack of action serves as a warning sign that the stock is preparing to trend lower. Conversely, and more importantly for our purposes, a stock that no longer declines on bad news is preparing to trend higher.

For most of the past three years, the news flow in the pharmaceutical sector has been decisively negative...

"Doctor Says Vioxx Can Cause Heart Attacks"

"Lipitor Linked to Liver, Kidney Damage"

"U.S. Probes Viagra Blindness Risk"

Indeed, as concerns about the industry's top three revenue generating products knocked out three legs of Big Pharma's stool, lawyers were working on how to take out the fourth...

On August 19, 2005, Big Pharma was hit with the verdict that threatened to topple the industry. An Angleton, Texas jury found that Merck was negligent in its marketing of Vioxx and awarded the plaintiff over $250 million in damages.

This was the first major case against Merck and it's marketing of Vioxx, and there were thousands more waiting to be heard. Certainly, any reasonable investor would expect to see Merck shares crash on the news and to witness a broad based sell-off in the pharmaceutical stocks in general. And, that's what we saw, sort of...

Merck shares dropped almost 8% on the news and the pharmaceutical sector, as represented by the Pharmaceutical HOLDRs Trust (PPH), fell 1.5%.

While no one likes to see their shares decline in value, Big Pharma shareholders had to be, at least, modestly relieved that the damage was not more severe. Of course, there were many more verdicts to come and the potential for a continuous stream of bad news ought to cause most reasonable investors to avoid the sector.

In December 2005, though, a funny thing happened...

U.S. Judge Eldon Fallon declared a mistrial in a Vioxx case after a Houston jury failed to reach a unanimous decision. Merck was widely expected to win this case, so having it declared a mistrial was certainly bad news for Merck shareholders.

Following the news, shares of Merck were basically unchanged. And, shares of the Pharmaceutical HOLDRs Trust (PPH) were actually up a fraction. The fact that pharmaceutical stocks didn't decline on the news of the mistrial was the first hint that the worst may be over for this sector.

Since Big Pharma investors have taken such a beating over the past three years, it may seem overly optimistic, or even a bit pathetic, to get excited about the stocks' failure to drop on bad news. But, when you're looking for the emergence of a new Big Trend, it often pays to reach for even the thinnest of branches.

Remember, the biggest gains often occur as an industry moves from bad to less bad.

Over the past few months, we've seen a few positive headlines that have helped to firm up the foundation of the industry -- Merck announced a major restructuring; Pfizer won a major ruling upholding its Lipitor patent.

We've witnessed positive technical action in the stocks, which indicates the sector is shifting its trend from bearish to bullish. And, we've seen an acceleration of money flow into Big Pharma stocks.

A few months ago, I recommended my Big Trend Report subscribers purchase shares of Pharmaceutical HOLDRs Trust (PPH). I still think this basket of major pharmaceutical companies is a great buy...

PPH is an exchange-traded fund comprised of 21 different stocks in the pharmaceutical/biotechnology industry. The trust is heavily weighted in favor of large capitalization pharmaceutical stocks with Johnson & Johnson (JNJ), Pfizer (PFE), and Merck (MRK) making up more than 50% of the total weighting of the fund.

The large weighting in favor of JNJ, PFE, and MRK may be of concern to some investors, but I think it's an advantage. Indeed, the bulk of the pain in Big Pharma over the past three years was inflicted upon these three stocks. Consequently, if this sector rebounds, then I think these issues will make up the most ground.

The Big Trend in Big Pharma is just beginning... are you going to catch it?

Good Investing,

Jeff Clark, editor
The Big Trend Report