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FBT Should Be A Core Position In A Life Science Portfolio

|Includes: First Trust NYSE Arca Biotechnology Index ETF (FBT)

The August biotech rally has taken us to the midpoint of the February top and May bottom and has gained momentum from the $8B RocheOTCQX:RHHBY acquisition of InterMune Inc (NASDAQ:ITMN). Look at the XBI SPDR S&P biotech ETF (XBI), a proxy for momentum and smaller cap trading due to its more diversified holdings. XBI is up 8.2% over 30 days despite a downturn on August 15. The large cap weighted ETF First Trust NYSE Arca Biotech Index (NYSEARCA:FBT) is outperforming all ETFs YTD up 32% and over the past five days is up 4.8% while the XBI is up 21.9% YTD and up 1%over 5 days. Over one year the FBT is still the leader beating the Fidelity Select Biotechnology Fund (MUTF:FBIOX) by over 17%!

The Rayno Large Cap biotech portfolio is up 27.8% YTD and 47.9% over one year. The Four Star Fidelity Select Biotech Portfolio has been lagging ETFs in 2014 probably due to its size buffeted by market volatility now that it has grown to over $8B as well as the underperformance of some top ten picks such as Biomarin (NASDAQ:BMRN). Many of you that have followed the markets over the past two years know that indexes and ETFs can outperform funds that are actively managed and that has been true lately in the biotechnology sector.

Smaller cap stocks are lagging in 2014 with iShares Russell 2000 Index (NYSEARCA:IWM) flat for the year at 115.36 with a double top in early March and early July. One reason that small and mid cap biotech stocks are underperforming is that many depend on index and fund buying and correlated to the IWM. However Q4 and Q1 has been strong seasonally for biotech so now is a good time for adding more speculative stocks. Many were beaten down during the March correction and will rally on a "risk-on" day like today with the Intermune/Roche deal. A major investment thesis is still the "food chain" effect whereby larger cap drug and biotech Companies boost their pipelines through M&A.

In summary:

  • The core position in any biotech portfolio should be FBT with an overweight of large cap biopharmaceuticals.
  • Traders should add XBI for momentum in a rally mode.
  • Add selected small and mid-cap stocks in near term for a Q4 rally.

Macro news has buffeted the market with concerns about Iraq/Syria, Ukraine and the FED. Nonetheless the S&P has hit new highs up 8% YTD because U.S. equities remain the top investment choice with low interest rates, good earnings and higher risks perceived in Europe, SA and Japan. The market remains resilient despite economic risks in Europe and concerns about growth in China have been pushed aside. Forecasts for higher interest rates persist but have been pushed out well into 2015 and even 2016 so a yield on the Ten Year Treasury is unlikely to hit 3% near term. The labor market is still a concern for the FED. In the past biotech and healthcare stocks have been less volatile on bad macro news. The healthcare sector (XLV) is the leader up 14.3% YTD followed by energy and technology.

Recently we have nibbled on a few small cap stocks from our 15% cash position expecting a fourth quarter rally. They initially moved over 5% but have since retreated in a market dominated by traders. We will continue to select stocks that we think will benefit from a year end rally but until most traders and managers get back to work in September it is hard to pick new stocks for a breakout.

Within our current Rayno Biopharma Portfolio our top small cap winners YTD are: Achillion (NASDAQ:ACHN), Albany Molecular (NASDAQ:AMRI) and Exact Sciences(NASDAQ:EXAS). Recent picks for a Q4 rally are Celldex Therapeutics (NASDAQ:CLDX) and Karyopharm Therapeutics (NASDAQ:KPTI).

Disclosure: The author is long ACHN, CLDX.