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Maine RX sends drug sector lower

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The AMEX Pharmaceutical Index (DRG.X) 312.39 -4.78% leads today's sector loser list and paces the major market averages lower after the Supreme Court upheld the state of Maine's program called Maine RX to lower the prices on prescription drugs. The ruling on Maine's program, which drug makers say violates federal law, is designed to use the state's buying power under federal Medicaid law to cut drug prices by 25% for consumers who do not receive health coverage or drug benefits through their jobs.

If drug makers want to participate in Maine's program, Maine RX stated that they would have to negotiate discounts and rebates with the state.

The court said that Maine's prescription drug policy program could not go forward and that an injunction against the state must still be lifted, and that today's ruling on the merits of the program and the court invited the drug companies challenging the Maine RX law to keep their challenge.

While the Supreme Court's ruling did not give Maine what it really wanted, an unqualified endorsement of the drug plan, which could set a precedence for other states, has weighted on drug stocks in today's trade.

Dow Industrials drug components Johnson & Johnson (NYSE:JNJ) $54.20 -3.28% and Merck (NYSE:MRK) $55.64 -6.4% have both been hit lower by today's Supreme Court ruling and have the Dow Industrials (INDU) 8,506 -1.98% falling 172 points. This action in the Dow has also put in place computer program trading curbs after the Dow fell 150 points earlier this morning. For computer programs to be allowed, the Dow must trade back to within 70- points of Friday's close to 8,608.97.

For the first time since the week of 03/14-04/04, we've seen the major equity indexes see trading at their WEEKLY R1 levels of support. This is being noted as "divergence" from prior weeks trading and comes not long after some of our key major index bullish % indicators either surpasses or have come very close to the 70% level of bullish %, which often alerts us to a more "overbought" market condition. As such, today's action has me now moving from a more "alert" stage to weakness on profit taking, to a more pro-active stance in managing bullish risk in my own account, as well as subscriber's accounts. The best way to do this in my opinion to raise profit stops on positions in order to protect bullish gains.

With market internals either at or nearing some more "overbought" level of bullish %, I would expect that support should be firm at the WEEKLY S2's. For the Dow Industrials, this would be near the 8,490 level, SPX at 921, OEX at 466 (has been traded today), NDX 1,120 and QQQ $27.80.

Again.... program trading curbs, which I believe trade from the pivot analysis levels are currently not allowed, but this doesn't necessarily mean that traders at institutional trading desks won't be monitoring some of these levels in a near-term attempt to replenish some inventories or square up some inventory after several weeks of prolonged bullishness. It is highly likely that institutions may have had to "short to the market" during normal market making activities, and will most likely be attempting some squaring of short inventories on weakness. I would view this type of action as more short-term trading opportunities for bullish intra-day traders to be watchful for and for bearish traders looking to establish early partial bearish positions to be cognizant of.

The weaker dollar is finding further bullishness in the Gold/Silver Index (XAU.X) 74.05 +3.24% in today's trade. In prior commentary, I noted the technicals for this sector looked to be improving as the XAU.X held a close above it 200-day SMA at 69.39 and this sector may also be benefiting from some sector rotation as profits are taken from other areas of the market. The AMEX Gold Gold Bugs Index ($HUI.X) 139.86 +3.55%, which is an unweighted index (the XAU.X is market cap weighted) was discussed in the OptionInvestor.com Index Trader Wrap on May 6, and based on our quick review from the "Beetle's Balanced Benchmark" portfolio of equities, would certainly hint that some equity asset allocation is being shifted toward this group of stocks.

Jeff Bailey

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