Profiting from the Cyclical Nature of Biotech Stocks

by: Everyday Finance

I've heard before that Biotech stocks do well in the fall due to the preponderance of trade/medical conferences where they highlight their clinical findings, pipelines and emerging technologies. The thought is that since the most prominent venues occur in the fall, the frenzy surrounding their prospects swells in the fall and then subsides at the end of the year. To date though, I've never seen any actual data to support this claim. So, I decided to do some research.

My findings actually support this claim, and I have the perfect strategy to capitalize on this phenomena.

According to my findings, which are based on the return of the Biotech Holders ETF (NYSEARCA:BBH), there is a very strong correlation with high average returns, median returns and positive returns for the months of September, October, and November that occurs only during this specific 3-month span. I chose BBH because it is a prominent ETF that has several years of history. It is important to be aware that the ETF is heavily weighted in Amgen (NASDAQ:AMGN) and Genentech (Private:DNA) since it is based on market cap. Going back several years, these companies were very much representative of the industry. If you want broader diversification for this strategy, other options out there are iShares Nasdaq Biotechnology Index Fund (NASDAQ:IBB), and the SPDR S&P Biotech ETF (NYSEARCA:XBI), which have different weightings.

What the attached chart shows is that over seven years, there was only one three-month span that on average, had positive returns more than half that time. There was also only one three-month that had both positive median, AND mean returns. The average return during those three months exceeded 3%. These three months were September, October, and November. If you leverage that into a 2x fund (below), that's 6% you could capitalize on each year, which is close the the long-run average return for an entire year! Of course, you need to take standard deviation into consideration.

To be more conservative, consider the market neutral option below. To take it to the next level, you could actually sell your holdings or short the indices listed due to the poor performance in December. There are myriad iterations of this strategy that could be employed, but the bottom line is, there's now some strong trends and data to support what used to be Wall Street lore to me.

BBH Chart

There are several ways to exploit this trend:

  • For the ultimate return, utilizing a leveraged basis, you could employ the Profunds Ultra Biotech fund, which provides double the return of Dow Jones U.S. Biotech index. Proshares has not yet launched a Biotech ETF, so for now, you'd have to go the fund route, which might carry a fee/high minimum with it, depending on your online trading account.
  • For a market neutral play (assumes the Biotech index will outperform the general market), you could go long one of the ETFs listed above and short the major indices. If selling ETFs/shares short makes you nervous, which it should, there are long ways to bet against the market. SH is the inverse of the S&P and SDS is 2x negatively correlated ETF, both by Proshares.
  • I'd love to hear your strategies as well. For a copy of the data table, feel free to contact me via my blog contact info below.

    Link to Profunds Ultra Biotech:

    Disclosure: I am not long any of the Biotech ETFs listed here, but may consider this strategy within the next few weeks. I will update if pursued.

    Screen Shot of Data Table:

    BBH Data Table