Biotech Bull Market Up 6%+ YTD: Key Trends To Watch Update #2

 |  Includes: IBB, PBE, XBI, XLV
by: Rod Raynovich

Biotech Bull Market Intact But Technicals Rule

On January 27 we reiterated our model for life science stocks for 2014. We will review each component of our model and where the sector stands after about a 5% correction off highs with the sector still up 6% YTD depending on the index, fund or ETF (IBB). Fidelity Select Biotechnology Fund (MUTF:FBIOX) is still up 9.3% YTD beating the largest ETF (NASDAQ:IBB) by 3 percentage pts.

The mid and small cap weighted XBI ($145.50) is up 11.76% YTD but off its 52 week (January 2014) high of $161.55. Some of the holdings of this ETF might be deemed speculative such as; Inovio (NYSEMKT:INO), NovaVax (NASDAQ:NVAX), Gale (NASDAQ:GALE), and Organovo (NYSEMKT:ONVO) so that accounts for the ETF's outperformance. The asset value is about $1B. The smaller ETF (NYSEARCA:PBE) is up 11% YTD with overweighting in Illumina (NASDAQ:ILMN) and leading large caps.

ETF holdings signal a new trend toward more active re-balancing as well as outperformance due to momentum small cap plays. In the short term this can work so long as the bull market sentiment continues. However many of these small cap biotech stocks are lacking revenue metrics and clinical milestones that can support valuations so volatility may surprise you.

Five Trends To Watch In Biotech-Preliminary Model

  1. Large Cap Biopharmaceuticals: metrics already reviewed-awaiting updated 2013 financial reporting. These stocks are supported by revenues, earnings and pipeline and are core positions. Celgene (CELG $153.56) on our sell list at $162 is down 10% YTD, but appears to be stabilizing at the $150 level. Look at Abbvie (NYSE:ABBV) and Bristol Myers (NYSE:BMY) as large cap biopharma stocks that pay a dividend. We also added RocheHoldings (OTCQX:RHHBY)to the portfolio as a large cap biopharma and Dx play.
  2. Key Technicals on Market indices: IBB, XBI, PBE, FBIOX, QQQ. Technicals are intact on pure biotech positions. We favor FBIOX and IBB which is weighted to large caps in item #1. The QQQs are down 3.25% due to a weak tech sector.
  3. Mid-Cap Emerging Growth in Immuno-Oncology: Stocks reviewed last quarter.We will review these stocks later this week: CLVS INCY MDVN PBYI SGEN etc. They are off their January highs but still strong for 2014 YTD.
  4. Speculative small caps: many already had a melt-down. See comments on XBI. Many stocks have corrected and are volatile. Stay away unless you are a day trader or better still a "gamer and day trader".
  5. Healthcare Sector Strength Overall. XLV is still flat YTD outperforming the SPY (S&P ETF) which is down 5% YTD.

CONCLUSION: The bull market in life science stocks is intact but the excess bullishness in January calls for profit taking to 15% cash in the sector. The diagnostics and tools sector should be weaker due to 2013 financial reporting/guidance hence a more critical view of valuations is likely particularly Price to Sales (P/S)

Major concerns: macro environment with China and emerging markets, ISM down, NASDAQ-100 now down 3.3% YTD, reversal of Treasuries to risk-off (TLT up 6% YTD), excessive bullishness in January 2014, etc. Will institutional buyers support current valuation levels?

Disclosure: I am long RHHBY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long FBIOX Fidelity Select Biotechnology Fund.