Biotech, Relative Strength

Biotech, Relative Strength

Biotechs have been one of the fastest growing areas in the stock market in terms of share price appreciation, sales, and earnings growth.  In a 2% growth world where liquidity is plentiful, it makes sense that one of the few areas where there is innovation and organic growth, will find its share price to be in demand.

Additionally, biotech is an area where there is still an opportunity to capture growth at an early stage. Another positive factor for biotechs is In contrast, many internet and tech companies are growing on the private market and only going public when valuations are already in the billions.

Biotech, Relative Strength

Of course, this performance has also brought out the contrarians who are proclaiming biotech to be in a bubble.  Even Federal Reserve Chairwoman Janet Yellen stepped into the fray, saying that biotech could be in a bubble.

And it is certainly true that biotech shares some attributes of a bubble, however these ingredients are necessary for something to be a bubble but not sufficient to be a bubble.  Some of these ingredients include the elevated valuations, frothy IPO market, and elevated levels of bullish sentiment.

However, the scope of this article is not to evaluate this matter.  For shorter timeframes, this discussion is purely academic.  And indeed, biotech being a bubble has been consistently spouted for years.  Yet, biotech continues to make higher highs, making skeptics look foolish.  In 2015, once again it is one of the best performers in the market, even as the S&P 500 is basically flat for the year.  Below is a three year, weekly chart, showing is performance versus the S&P 500:

Biotech, Relative Strength

On a shorter term timeframe, biotechs have been consolidating in an orderly manner even as the broader market encounters selling pressure.  Due to the market’s healthy internals and liquidity inflows through February, once this selling pressure subsides, markets should bounce back to make new highs.  Breadth has been consistent more with rotation rather than distribution, as certain areas of the market have remained resilient despite the recent volatility.

Biotechs are certainly one of these areas as the six month, daily chart below shows:

Biotech, Relative Strength

So far, biotechs have mildly backed off its breakout to new highs, falling back within its range.  Such a pullback given the market environment is to be expected, especially after a big move higher over the past month.  However, the low volatility of the move is remarkable given the elevated valuations in the space as well as the extreme bullish sentiment.

It is evidence that institutions continue to add exposure and support prices.  They use turbulent market environments to add shares, as it allows them to do so without affecting prices too much.  However, institutions still create footprints and low volatility trading in a high beta asset during a period of broader market volatility is one footprint of institutional accumulation.

Going forward, this looks to be a compelling, low risk entry point for traders who want to play a breakout with a break of the range, being a logical stop point.  However, this setup is dependent on the broader market turning higher, continued weakness enhances the chances that the range breaks lower.