Even If Eli Lilly Stock Continues to Shine, Stay Away from This Pharmaceutical ETF

One of the biggest misconceptions about ETFs is that they are highly diversified “baskets” of stocks. Sometimes they are. But as the iShares US Pharmaceuticals ETF (IHE) indicates, even with 60 stock holdings and $1 billion in assets, large ETFs can still be more of a duopoly than a democracy.

With 44% allocated to just two stocks, and 60% allocated across the top six names, the rest are essentially along for the ride. With that important note established, let’s look at the potential up-move IHE is hinting at.

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We have to separate whether the strong-looking chart pattern reflects the pair at the top, or a more wholesale rally brewing in pharma stocks.

The chart looks to be on the verge of breaking to new highs, in a way that could lead to a new price trading range. However, this market, now flooded with technicians, is going to test that first. After all, this industry does not get the same “hall pass” that big tech does.

But if you are planning to buy IHE to capture a broad rising tide across the pharmaceutical industry, you need to freeze. Look under the hood of this vehicle, because IHE features an extreme structural configuration that makes it wildly different from other major drug ETFs. This is not an industry-wide breakout — it is an absolute illusion of sector strength masked by a tiny, hyper-concentrated handful of stocks.

The biggest driver is Eli Lilly (LLY). How much has this stock led the industry since last fall? When I pulled up this chart, I still had my old trend channel drawn. When it busted up through $850 it ran to $1,100 faster than you can spell “Glucagon-Like Peptide.” That’s the full name of GLP-1 drugs, the ones that took LLY from “one of the gang” to “leader of the pack.”

Then there’s formerly stodgy Dow Industrials ($DOWI) component stock Johnson & Johnson (JNJ), which has cooled off substantially. And frankly looks lower to me. I’ll spare you all 10 of the top stock charts, and simply say that collectively, they are a mixed bag. That tempers my enthusiasm for IHE.

Because IHE screens for U.S. drug manufacturers and weights them by absolute market value, it has created a highly skewed profile. This structural difference completely answers the question of what is driving this breakout.

The “pharma rally” is a deeply exclusive party with an incredibly strict guest list. When LLY and JNJ catch a bid, they mechanically drag the cap-weighted IHE upward, printing an “industry breakout” headline that masks the distribution occurring across the smaller, struggling components inside the basket.

IHE is an incredibly potent, high-velocity trading instrument if your core goal is to maximize exposure to the absolute biggest mega-cap pharmaceutical names in the U.S. But until that pair falls back to earth relative to the rest, the rest of IHE’s drug stocks are best viewed as a stock-picking shopping list rather than a case to own the fund. The VanEck Pharmaceutical ETF (PPH) is another drug ETF with a more balanced profile, for those looking for less of a two-ticker show.

Rob Isbitts created the ROAR Score, based on his 40+ years of technical analysis experience. ROAR helps DIY investors manage risk and create their own portfolios. For Rob’s written research, check out ETFYourself.com.

On the date of publication, Rob Isbitts did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com