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Biotech Bull Market: OK Let's Just Call It A Bubble

|Includes:iShares Nasdaq Biotechnology ETF (IBB)

Biotech May Be A Bubble-But What to Do?

The blogosphere is trying to temper bullish sentiment with a lot of "bubble "talk even though the cable channels are still pumping biotech. If you have been around biotech for 25 years especially during the last true bubble -1999 -you should be a little skeptical of the recent huge moves. It is good to be wary of parabolic curves. The sector (IBB $272.6) is up more than 20% YTD after being up over 60% in 2013. Will there be a reversion to the mean in 2014 or will investors need a major shock to pull back on their life science investments? I have written extensively on the "Biotech Bull Market" even in the early stages, but it now appears more frothy with more investors (even retail) jumping in, IPOs at a record pace, pumping rampant, and good news prevailing. But we may be approaching a "piling on " phase, meaning that momentum and speculation has the upper hand. Moreover biotech investors are well connected so individual stock momentum gets a turbo boost on newsworthy events.

First what are the symptoms of a "bubble":

  • Traditional metrics cannot measure valuations nor extrapolate revenues let alone earnings.
  • The shape of the stock appreciation curve looks more parabolic.
  • Small cap stocks move 10-20% in one day on seemingly minor scientific news.
  • Scientific or industry experts extrapolate clinical data to breakthrough products 3 years away.
  • Stock and sector volatility increases up and down.
  • Institutions can move their favorite stocks at will because they have big bucks and there are few sellers.

As we approach the one year anniversary (4/4/13) of our first article on the subject " Is There No End To The Biotech Bull Market we are up 80% on the sector and much more on our top picks: ALXN, BIIB, CBST, GILD, ILMN, PCYC, REGN. None of the risks we mentioned last April have been able to temper the bullish sentiment including some severe 10% corrections and a meltdown of a few small cap stocks. We also know that for all the negative "train-wreck" talk about the Affordable Care Act (ObamaCare) that it is seen as bullish for biopharmaceutical stocks because of more patients.

What To Do?

NASDAQ has yet to reach the 5000 level of 1999 but we only have 700 points to go. Biotech has already exceeded its 1999 highs with many of the same biopharma stocks that were leaders at that time: Amgen, Biogen Idec, Gilead etc.The Fidelity Select Biotech Fund (MUTF:FBIOX) is up 217% since January 2000 despite taking two big hits in 2000 and 2001.This is an annualized return of 15.5% over 14 years, not bad for sector that is considered high risk by some. The total returns for FBIOX over 10 years is 311%. By comparison the (NASDAQ:QQQ) PowerShares NASDAQ-100 ETF is up 145% over 10 years. So over the long term the sector is a resilient leader.

We have articulated Five Key Trends to track in the biotech bull market. The only near term trends of concern are excessive speculation and valuations of some mid-cap emerging growth stocks. The underlying factors driving the bull market are still intact:

  • Overall Strength in NASDAQ and technology stocks.
  • Overall strength in healthcare sector (NYSEARCA:XLV)
  • Scientific breakthroughs in the life sciences: genomics, targeted therapy and personalized medicine.
  • Robust product pipelines and new product approvals.
  • M&A and deal potential driving value; but large cap M&A is slowing.
  • Demand for biotech stocks exceed supply. Liquidity prevails. Strong trading volume.
  • Low cost of capital courtesy of the FED.

If you are fully invested in life science stocks there is little to do except raise a little cash buy a Tesla or sell a big chunk and take off for Madagascar for a few months. What has worked is holding the core Rayno focus stocks. If you are underinvested you can add an ETF or a pure biotechnology fund. The sector is trading in "lock-step" so stock picking up until now is not needed with the sector outperforming or if you have a portfolio of at least five large cap stocks. Technicals are more important because stock performance is decoupled from fundamentals. If you do not have life science stocks in your portfolio the decision is more difficult.

Companies are in a very favorable position to raise capital because investment banks know there is strong demand for life science stocks. Many technology and healthcare funds want these stocks in their portfolios .

So getting back to the bubble. You should feel better now after calling the biotechnology market a bubble. You are now psychologically prepared for a 10% correction or even a major event that would change the fundamentals of the sector like cuts in drug reimbursement. But a bubble can still get bigger and last much longer with many trading opportunities. Get it while you can.

Disclosure: Long Fidelity Biotechnology Fund (FBIOX), long and short a trading basket of mid and small cap life science stocks.

Disclosure: I am long XLV.

Additional disclosure: I am long Fidelity Select Biotech (FBIOX) and long/short trading several biotech and diagnostics stocks.

Stocks: IBB