INVESTING: Don’t plunge into the market rally, but buy in the dips

Americans spend a ton of money on health care. (The fact that most of that money is not their own is the leading problem with our health care system.) You would think that, with all the spending, pharmaceutical stocks would be a gold mine. Even though the sector has been the leading performer over the last 100 years, good drug stocks have been hard to find so far this century. But eight years after hitting their peaks, something might be brewing, and the stocks are starting to respond.

Right before the election last November, drug stocks were pounded because investors thought Democrats were going to take control of the House and the Senate. Well, investors were right about the election outcome, but they were wrong about the effect that would have on the industry.

Socialized medicine and price controls eventually will kill off a great American industry, but I don’t think the Democratic majority is big enough to pull off the type of wrecking-ball policies the party really wants.

Instead, there has been a lot of talk, a little legislating. Congress is trying to pass a law allowing Medicare to negotiate for drug prices-a measure I believe the president will veto. As I mentioned a few times in late October, the pessimism surrounding these stocks was too high then, which led to strong returns over the last five months. The Investors Business Daily health care index is up 13 percent so far this year. (That’s a little better than the tip you get from the taxi driver!)

It was the excessive pessimism that drew me to drug stocks last fall, and it is the same situation that is keeping me in them now. Merck recently blasted to a four-year high, erasing all its Vioxx-related losses. Even so, put-buying (an options strategy that gives an investor gains if the stock falls) is near alltime highs. And it’s the same picture for the other major drug companies. In other words, as the stocks go higher, people are betting against them even more.

As with any investment topic today, there is an Asian angle with the drug stocks. I don’t know if there is hard proof yet, but the theory is that as people in Asian countries grow wealthier, they will have an interest in spending more on their health. And drugs are a lot harder to copy than sneakers.

Right now, I would put health care stocks in a similar category as the rest of the market. Things are overbought, and there is the potential for pullback-although it most likely will be shallow and short-lived. My mantra for 2007 has been buy the dips but don’t chase the rallies, and that is just as true with the drug stocks as it is with my other favored areas, such as utilities and materials.

Look back at what I wrote on the night of Feb. 27, the day the market fell 4 percent. I said it was a buying opportunity, and any money you put to work then has performed handsomely. You probably don’t want to run off and buy a bunch of stocks at these elevated levels, but watch for those down days. Until further notice, the market remains a buy-the-dip environment.