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Long/short equity, research analyst, biotech, healthcare
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I never like to watch people get trounced in the market, but have come to realize it's part of the natural order of things. A cyclical phenomenon that leads many to shout from the rooftops that the market is manipulated, the odds are stacked against them, or other anesthetizing mantras that help one cope with the sea of red in their brokerage account.

And well, yesterday was one of those days. Although the broader market appears to be correcting as well, previously red hot healthcare stocks surely led the rout.

Let me give you some descriptive statistics to help you wrap your head around the magnitude of this bloodbath.

91% of the healthcare sector was in the red yesterday. 24% of the sector dropped more than 5% on unusually high volume. The biggest loss among large caps was Biogen (NASDAQ:BIIB) at 3.92%.

In short, the correction truly occurred in mid and small cap healthcare stocks. And that is exactly the point I'd like to draw your attention to.

Perhaps you are seeking an explanation for your losses this morning, especially if you were invested heavily in Arena Pharmaceuticals (NASDAQ:ARNA), Galena Biopharma (NASDAQ:GALE), or Peregrine Pharmaceuticals (NASDAQ:PPHM) yesterday. Why? Because all three of these stocks were big losers in yesterday's market and sector wide correction, and their respective social feeds are abuzz with conspiracy theories.

While conspiracy theories are good for a laugh, I do have some bad news for investors in these three stocks. You have no one to blame but yourself for holding during this turbulent time. And this pending correction was painfully obvious.

In fact, one week ago to the day I penned this prognostication on Seeking Alpha:

I think most small caps are going to struggle this year, making them ripe targets for short plays. Don't be surprised if a number of the small caps that doubled or tripled in 2013 give back most of those gains in 2014.

Simply put, I expect small cap biotechs to crash this year under the weight of the global financial milieu, combined with their recent face-melting gains. Large caps with newly launched products appear to offer investors a safe haven

Who got laid to waste in yesterday's correction? Mid and small cap stocks. Large cap pharmas did okay for the most part.

I am not writing this piece to toot my own horn. Far from it.

Instead I think retail investors in the healthcare sector would be wise to use this event as a teachable moment.

As shown by my last article on the matter, this drop among small to mid-cap stocks was entirely predictable. The problem, as I see it, was one of irrational exuberance.

What do I mean by irrational exuberance?

Because the entire healthcare sector has been soaring over the last two plus years, I think many retail investors got caught in group think mode. Consequently, they acted like lemmings falling off a cliff, when they should have been more flexible to avoid this pitfall. If this happened to you, the best thing you can do is learn from the experience. You already paid the tuition, so learn the lesson.

Why was this downside move so predictable?

Once the broader market began to react negatively to the QE tapering combined with the pullback in emerging markets, the next logical step was that investors would seek safer assets. Within the healthcare sector, large cap pharmas tend to perform well in turbulent times because people are still going to buy their medications, medical devices, and use diversified healthcare services. Healthcare is largely independent of the vagaries of the market surprisingly enough. And yes, I meant this statement to be purposely vague.

On the flip side, I thought it was fairly obvious that investors were going to shed speculative investments like developmental stage biopharmas that inhabit the small and mid-cap realms. So, looking back, you don't need to resort to staged-moon landing types of ideas to explain this downtrend. It's not much of a mystery at all quite frankly.

Ok, so what's ahead?

Now this is a much more difficult question to answer. I know the temptation tomorrow is going to be to buy stocks like Arena and Galena 'on the cheap.' But the real question is, are they really cheap? What are they worth in terms of their fundamentals?

I point this out because, in my view, this year will place a heavier emphasis on fundamentals than the previous two. So, if you think it's time to double down to recoup your losses, I would caution you against such a strategy.

Before doing so, I suggest you watch how Gilead's (NASDAQ:GILD) earnings release plays out over the next few sessions. To my mind, this event is going to be telling in terms of the direction the market will take this year for healthcare stocks. Put simply, does it value earnings or not?

As such, my advice in the near-term is to conserve cash and wait for the market to come to you. Don't force anything, and certainly don't try to catch a falling knife.

Good luck fellow healthcare investors!

Disclosure: I am long GILD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Dear Healthcare Investors: The Correction, It's Here