Waving The Biotechs

09/05/06 02:13:23 PM

by David Penn

An Elliott wave analysis of the consolidation in biotechnology stocks underscores the potential for weakness.

Security: BBH
Position: N/A

The semiconductor stocks have been the stars of the late summer rally since mid-August. The SMH is looking to hold a breakout at about 33.5, with nearest resistance at 35. The market pulled back on light volume during the Thursday and Friday going into Labor Day weekend, and that mild selling was seen in the otherwise strong semis.

FIGURE 1: BIOTECHNOLOGY HOLDRS TRUST, WEEKLY. The spring/summer consolidation in BBH in 2006 could be the end of the decline that began in the autumn of the previous year. Or it could be merely a pause before the continuation of the downtrend. A break below the 170 area would be an especially bearish development at this point.

Graphic provided by: Prophet Financial, Inc.

The biotechs were also trying to move up. All they've really done is move back to the top of their trading range, but a breakout to the upside could be a big deal if it were to happen. The biotechs topped out back in November 2005 and have been sliding ever since. That was at least a month before the semiconductors topped and began moving lower. On the weekly chart (Figure 1), the biotech consolidation looks bearish to me, but very much like a way station to lower lows. In fact, if the biotechs broke down from here, I would not be surprised to see them test the 2005 lows, easily 25% lower than the consolidation low.

You could call the sideways consolidation in BBH a fourth-wave double-three wave 3 ended in early May. The a-b-c or W of the double three runs to the high in early June, with the X three bottoming at the end of the month (Figure 2). The second three looks like it is a triangle. Triangles aren't ordinarily parts of double threes, but they certainly can be. What is particularly interesting about how this triangle appears to be setting up is that it might appear to many traders like an ascending triangle bottom, rather than the bearish reversal wedge it might turn out to be if it is in fact the second third of a fourth-wave double three in a downtrend.

FIGURE 2: BIOTECHNOLOGY HOLDRS TRUST, DAILY. This double-three correction appears to consist of a flat (the a-b-c of wave W) and a triangle (the a-b-c-d-e of wave Y). Note how wave Y runs into resistance at the downtrend line from the November 2005 peak.

Graphic provided by: Prophet Financial, Inc.

The triangle is also set up for a major test of the trendline that defines the biotech market's bear market from the November 2005 top. If the move higher were to fail, then we are coming close to an excellent place for it to do so.

All this projects a fifth-wave bottom in the biotechs between 141 and 149. I'll be eyeing these stocks very warily over the next few weeks. If the biotech rally fails at a time when even the semiconductors are getting a bid, then they might not just fall to the bottom of their consolidation range when the broader market reverses to the downside. They may plunge through it.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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ELLIOTT WAVE

Waving The Biotechs

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