Small and mid-cap biotechnology equities are breaking out after of the bottoms set last quarter. This trend appears likely to continue this quarter, and through the end of the year. I believe biotech equities will substantially outperform the broader market over the next several weeks and months. Both the Direxion Daily S&P Biotech Bull 3X Shares ETF (NYSEARCA:LABU) and the SPDR S&P Biotech ETF (XBI) are reasonable allocations at this time, with LABU being more of a short term trading vehicle for this probable continuing move higher.
The bottoms put in by many biotech companies earlier this year were significant. After extreme outperformance in 2020, biotech equities were among the earliest to peak. XBI peaked in early 2021, and subsequently spent the following year and a half in a sustained decline that did not stop until rather recently.
This coming out of this prolonged round trip move back to the pandemic lows, biotech equities have been strong performers. Since bottoming, XBI has appreciated by over one-third, and LABU has more than doubled.
Despite this significant appreciation over the recent past, these equities are still substantially below their 52-week highs, and LABU is still less than one-third of its valuation at the start of 2022.
While it is likely the case that the biotech industry became substantially overvalued in late 2020 and 2021, it is equally likely that the industry became significantly undervalued last quarter. Despite the strong gains many biotechs, as well as both the XBI and LABU ETFs, have seen since June, they still appear undervalued and likely to outperform from here.
Beyond mere valuation, it appears probable that larger pharmaceutical companies will continue to acquire small prospective companies and their technology. There has already been a significant number of recent deals. In May, Pfizer (PFE) agreed to acquire Biohaven (BHVN), maker of the migraine drug Nurtec, for $148.50 per share. Also in May, GSK (GSK) agreed to acquire Affinivax, a clinical-stage biopharmaceutical company, for a $2.1 billion upfront payment and up to $1.2 billion in potential development milestones. Also, In June, Bristol-Myers Squibb (BMY) announced that it would acquire Turning Point Therapeutics (TPTX), a precision oncology company, for $76 per share.
XBI and LABU are modified equal weighted ETFs. The primary difference is the leverage, where XBI has none and LABU is 3x. Another difference is the management fee, where XBI charges 0.35% and LABU charges 0.96%, or nearly triple the fee. As a result, LABU is generally better suited as a shorter term trading vehicle.
I believe small- and mid-cap biotechnology equities are likely to maintain their recent positive momentum. It appears highly likely that XBI and LABU put in long term capitulatory bottoms last quarter, and the underlying equity baskets are now substantially outperforming the market. I believe biotechnology outperformance is likely to continue through the remainder of 2022, with a possible pause in the fall before mid-term elections.
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Disclosure: I/we have a beneficial long position in the shares of LABU, XBI either through stock ownership, options, or other derivatives. 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.