Biotech Is Back From the Dead

Stomach-wrenching volatility hit the markets last week, but one popular sector escaped the roller coaster ride. A solid rotation into biotech stocks lifted the group and raised hopes that their long period of underperformance was finally coming to an end. Let's see how the embryonic move has impacted the speculative sector and its major players.

The intense buying pressure was noteworthy, appearing out of thin air during the first trading week of 2007. This obvious rotation signaled that institutional capital was coming out of last year's highfliers and taking a test drive in this beaten-down sector. Let's hope that industry developments continue to support the improving tape.

I'm a chart guy who can't list all the fundamental reasons why the biotech sector has chosen this moment in history to wake up from the dead. Those interested in the structural reasons for the group's awakening should check out Adam Feuerstein, TSC's resident biotech wizard, who's returned to his desk after a two-year absence.

Suffice it to say that biotech stocks have been stuck in the mud for a very long time. That makes the current advance especially interesting but also puts it onto a limited timer. Clearly the emerging rally has a limited shelf life to attract interested shareholders, or it risks outright failure.

The weekly chart of the Biotech HOLDRs Trust (BBH - commentary - Cramer's Take) highlights the multiyear high struck in November 2005, followed by a long correction that gave up half the gains of the prior rally. The instrument bottomed out in July with the broad market, but its recovery came to a screeching halt in late October.

Obviously, the first target of this rally will be the high just above 193. Unfortunately, that's really close to last Friday's close, so I don't recommend new positions in the group at this time. First let's see how price deals with this notable barrier. There should be plenty of time to get on board if and when this level is mounted.

Alternatively, the risk/reward profile perks up significantly if price falters and drops back to 181. That level marked the springboard for last week's rally. An entry there could book a decent profit up to resistance and allow for greater patience while that key level gets tested.

In any case, the current positioning of the exchange-traded fund suggests there's no rush to "pile in" to the biotech sector. That's generally true of any group that starts to recover off significant lows. We may believe we're patient, value-oriented players, but it's hard to stomach the back-and-fill volatility that's common at these conflicted price levels.

It's too early to jump into the Biotech HOLDRs Trust, but individual biotech blue chips might have their own tales to tell. So let's see if their weekly charts will support our speculative cash at this time.

I've written many bearish pieces on Genentech (DNA - commentary - Cramer's Take) in the last year, but I will now shut up and give the blue-chip giant another chance to prove its worth. The weekly chart shows price topping out in December 2005 after a powerful rally. It pulled back until April 2006 and dropped into a tight congestion pattern, where it's been stuck for the last nine months.

Last week's uptick wasn't too impressive, given the broad sideways pattern. It will take a convincing rally above 87 for the weekly pattern to turn around and look bullish again. Even so, the journey from that level up to the multiyear high at 100 could be a rocky one, so I'd avoid this stock until more buying signals emerge.

Amgen (AMGN - commentary - Cramer's Take) topped out in September 2005, a few months ahead of other biotech blue chips. It then dropped into an orderly correction that found support in late July. The stock shows constructive price action since that time, but its outlook remains clouded. At a minimum, this uptick needs to confirm that the summer low was the bottom for the correction.

I like the bounce off the 62% retracement of the 2005 rally, but accumulation just isn't strong enough yet to predict a swift recovery. A few big green volume bars would help tremendously. Without those on the weekly chart, I advise caution until the stock proves itself at higher levels. In particular, keep watch on three-month resistance over 75.

Genzyme (GENZ - commentary - Cramer's Take) bounced in May and stalled out in August, well ahead of other sector leaders. It then spent 13 weeks building an ascending triangle pattern before breaking it to the downside in December. This violation lowers the odds that last week's rally will show immediate follow-through.

In context, this rally is just a pullback to resistance after a notable breakdown. The sequence of events also predicts that selling pressure will return to the stock in the next week or two. What will it take to improve the clouded technical outlook? Watch for price to push up to 70, hold that level for a few weekly bars and then charge higher.

Unfortunately, this sector review hasn't been encouraging at all. The biotech generals still face significant hurdles, despite the warm tidings of last week's rally. This warns readers to tread lightly in the group until it confirms the uptick with broad accumulation and a rally through intermediate resistance levels.

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Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by TheStreet.com.

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