Published: May 10, 2010

The medical device sector is still reeling from the healthcare reform bill.

Slapped with a 3% tax increase effective January 2013, many medical device manufacturers and distributors such as Medtronics (NYSE: MDT) and Stryker (NYSE: SYK) fear future sales and earnings growth will be limited. These companies will be impacted by the levy and incur high costs to obtain regulatory approval on new products.

The iShares Dow Jones U.S. Medical Devices Index Fund (NYSE: IHI) is an exchange-traded fund (ETF) that seeks to replicate the performance of the medical device sector.

Currently, there are 42 medical device manufacturing and distributing companies held in the fund. Top holdings include Medtronic at 10.2%, Thermo Fisher Scientific (NYSE: TMO) -- 7.3%, and Stryker Corp -- 6.2%.

Technically, IHI seems at an important turning point -- a major correction could be looming.

On Friday, April 30th, the fund hit a 52-week high of $60.75. It also encountered long-term historical resistance near this level, and dropped about $4 this week in conjunction with the overall market decline.

The shares have broken the major uptrend line that began in March 2009 when they hit a low of $31.43. IHI has also fallen below its 10-week moving average and is perilously close to falling below its 30-week moving average which currently intersects at 54.21. There is some support near $51, the intersection of the lower Bollinger band, but more substantial support is near $47.50 -- a level approached during the panic decline Thursday.

The indicators are mixed, but have a bearish tinge.

• Since mid-March, MACD has been essentially flat, but now appears to be on the verge of giving a sell signal. The MACD histogram has inched into negative territory..



• The relative strength index (RSI) -- which bottomed in mid-November 2009 -- was in an uptrend until this past week. This week it plunged and is in near freefall after having corrected to 53.7.

 
• Stochastics, which also shows the security is still overbought, is close to giving a significant sell signal, which would happen if both %K and %D fell below 80.
  

From a fundamental perspective, IHI is richly valued on at least one measure. The fund has a P/E ratio of nearly 30. In comparison, the iShares Dow Jones U.S. Healthcare Sector Index Fund (NYSE: IYH), which seeks to replicate the performance of U.S. healthcare stocks, has a P/E of less than 20.

Given that IHI appears richly valued and technically vulnerable, I believe the fund could be a great short opportunity.

-- Melvin Pasternak
Editor, Double-Digit Trading
Co-Editor, Trade of the Week

P.S. For my top individual medical device short candidate, a stock which has the potential to deliver even larger returns, see this week's issue of my Double-Digit Trading newsletter.