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A Better Way to Play Pharma

So the yields are in the same ballpark, and both TIPS and pharmaceuticals have limited upside.

What about the downside for health? This idea would make no sense if Pfizer and Merck (MRK - Get Report) plummet from here.

But here is an anecdote that may point to a bottom. When I first wrote about my Pfizer revenue theory a year and a half ago on another Web site, I received an incredible amount of hate email. When I repeated the idea in a Columnist Conversation post last week, I only got one email that mildly disagreed. This leads me to think the selling could be about done.

Three things might be enough to tie this theory together: similar yield, limited upside and limited downside.

If the broad market provides below-average returns for the next few years, as some contend, and if my thoughts about pharmaceuticals hold water, it might result in the pharmaceutical-centric ETFs averaging 2%-3% returns plus the dividend. That's not much different from what TIPS are likely to do.

But pharma ETFs offer something TIPS don't. Despite what anyone thinks about the fundamentals, the entire sector could rally significantly at any time for no reason at all. This has happened repeatedly throughout market history. Pharma-centric ETFs should participate to some degree in a broad market rally -- this can not be expected of TIPS.

This idea makes some sense if you believe that, after being cut in half or worse, domestic pharma stocks have now seen most of the selling.

At the time of publication, Nusbaum was long JNJ, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, Ariz., and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.

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