Be Careful With Bifurcated Biotech

This column was originally published on RealMoney on Feb. 5 at 12:07 p.m. EST. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

Biotech stocks perked up considerably at the start of January, pointing to a long-overdue rotation into the speculative sector. I looked at this promising development as it unfolded, noting mixed signals among the group's highest-capitalized stocks.

Let's re-examine these top players today and see how their charts are shaping up.

Not surprisingly, sector components are pulling in opposite directions, with a handful of big names charging to new highs while the balance struggle to attract buying interest after decent January gains.

This bifurcation follows the cautionary comments I made in my last look, when I noted that the emerging uptrend needed more time to mature before it could pay off.

Clearly, though, the depth of conflicting price movement within the sector is much greater than I expected at that time. Of course, this is an emerging theme throughout the equity markets these days, with the S&P 500 index charging to six-year highs while the most popular big-cap tech stocks remain stuck in the mud.

Amgen(AMGN Quote) landed a sucker punch to the group in late January when it sold off hard after missing earnings and triggering anxiety about its broad drug pipeline. This is the second-highest-capitalized biotech, behind Genentech(DNA Quote), so its sharp downturn knocked the wind out of sector-focused indices and exchange-traded finds.

Fortunately, additional downside appears limited to $68 or so in the short term. Consider how stabilization in this single issue would have a beneficial effect throughout the biotech sector as we head through February.

But let's not overreact and jump back into this issue too quickly. Instead, let other folks risk their capital searching for a bottom.

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At the other end of the spectrum, look at what happened to Gilead Sciences(GILD Quote) after its earnings report last week. The stock catapulted out of a three-month bull flag and printed a new high on four times its average daily volume. The breakout sets up ideal conditions for the stock to resume a secular uptrend that's shown little weakness in the last decade.

But this is a dangerous place for interested buyers to pick up new positions. Consider the old trader's adage that "gaps get filled." This truism predicts the stock will drop down and test last week's breakout before moving substantially higher. Alternately, sideways action near current levels, lasting several weeks, might also offer good entry points.

Gilead Sciences ranks just below Amgen in sector capitalization, so its sharp contrast in performance highlights the divergent technical picture. This conflict makes it really tough for interested parties to make logical buying or selling decisions about the group. Unfortunately, things may not get substantially better or worse in the months ahead.

This split performance is creating yet another problem. Smaller biotechs depend on blue-chip leadership as they wait out the long months leading into research milestones and drug approvals. Mixed signals at the top are hurting their efforts to attract willing buyers, despite relatively attractive pipelines.

January performance of sector-leader Genentech lies dead-center between the extremes of its two compatriots. The stock gapped out of a 10-month basing pattern on Jan. 11 and charged into resistance near $90 before starting to pull back two weeks ago. That decline is now testing the boundaries of the breakout day.

This pattern looks like a buying opportunity that will demand precise timing. The solid base should keep a falling price above support, but relative strength is still declining. Readers interested in getting on board should focus their attention on the gap at $86. Look for the stock to fall into it and spike back out as a high odds signal the downturn is over.

The balance of the blue-chip leadership in this sector is caught in the middle of this evolving conflict. Specifically, Genzyme(GENZ Quote), Celgene(CELG Quote) and Biogen Idec(BIIB Quote) all show constructive but uninteresting patterns that could move in either direction this February. Frankly, I'd stay away from all of them until the dust settles.

Finally, let's look at the negative impact of the Amgen selloff on the Biotech HOLDRS Trust(BBH Quote). This instrument broke out of a three-month congestion pattern in January, in tandem with the Genentech rally. But the uptrend failed miserably after the Amgen news, dropping price back under new support near $193.

Failed breakouts are difficult to overcome, as we've learned with the Nasdaq 100 in recent weeks. Once set into motion, the odds favor downside continuation until buyers caught in the false rally get washed out of the system. With this biotech proxy, a decline would translate into a trip back to the 200-day moving average at $185.

The first-quarter prognosis for biotech stocks is less positive than it was last month. Hopeful buyers moved into the group in January but haven't been rewarded yet for their considerable risk-taking. These impatient folks may just cut and run if sector deterioration continues while better-positioned market groups charge to multiyear highs.