Feeling-the-Bern

Thursday’s speech by Janet Yellen holding out hope for a rate hike before the end of 2015 may have helped breathe life into bank stocks but it seems that no amount of medical intervention could have saved healthcare stocks.  Privately held Turing Pharmaceuticals might have sparked the political furor among democratic presidential candidates over drug prices when it raised the price of Daraprim by 5,000 percent, but it was their publicly traded peers who felt the pain with most major biotechnology and pharmaceutical companies down by double digits last week.  Beyond the headline, the sector has been under significant selling pressure since the start of July as investors used the on-going market weakness as the justification for profit taking and for the first time in a long time, ETFG’s list of top behavioral movers isn’t dominated by biotech names.  This week we look at our data to see whether a case can be made to support the bullish hopes for biotech names even amid a correction or whether the bears will prevail.

It’s hard to argue against the idea that the bears are firmly in control of biotech’s fate with the sector heavyweight, the iShares NASDAQ Biotechnology ETF (IBB) down nearly 22% since its peak on July 20^th and now up a mere 2.29% in 2015.  Price momentum is one of the two major factors in our behavioral scoring model and that steep sell-off on increasing volume helped push IBB off our list of top behavioral scorers after having spent most of the last three years as one of its key members.  IBB has seen a more than 22% drop in its behavioral score over the last two weeks as its short-term momentum score dropped Friday into its lowest quartile while even the long-term momentum ranking is now below its long-time average, a pattern repeated among all the larger biotech ETF’s like the SPDR Biotechnology ETF (XBI) and the Market Vectors Biotech ETF (BBH).

Underpinning that technical weakness is a fundamentalist viewpoint that depends on two key arguments.  The first is the idea of mean reversion or that biotech stocks were primed to fall after four strong years from 2011 to 2014 that saw IBB consistently outperform the broad market and deliver a cumulative return of 227% to the S&P 500’s 63.7%.  The second argument speaks more to emotions than logic and was exacerbated by the debate over Turing’s price hike.  The debate over the Affordable Care Act and subsequent court battles acted as a major depressant on P/E multiples in the healthcare sector for a number of years with the Health Care Select Sector SPDR (XLV) underperforming the S&P 500 in 2009 and 2010 despite the stable and improving earnings outlook following the Great Recession.

And while the bulls like to meet fear with fear (of missing out on big future gains), we’ll start the bullish case by going back to our Quant Report.  While IBB and the rest of the biotech funds have seen a serious momentum shift over the last several months, they still have a long way to go before they’ll find themselves at the bottom of the heap with the emerging market and energy funds.  Price momentum is only one of the factors that makes up the behavioral score; the others are sentiment indicators like short interest and implied volatility and while the biotech funds might have momentum scores in their lowest quartiles, they still have elevated levels of short-interest that could add more fuel to the fire of a future rally.  Our technician friends would be the first to tell you that with three largest biotech funds all within spitting distance of oversold territory based on their 14 day RSI scores, there’s the reasonable chance for an oversold bounce before too long which could turn into something greater thanks to those oversold conditions.  However, the bullish case has more to it than just a short-term bounce and in fact it rests on the notion that the recent sell-off, like a good bloodletting, has in fact been a positive development for investors.  Record high valuations among healthcare names has been a regular topic here at ETF Global and many of the biotech bulls will be sure to point out that even large-cap biotech names like Gilead (GILD) or Regeneron Pharmaceuticals (REGN) can boast of double digit EPS growth rates that strongly outpace that of the broader market.

Ultimately what makes these bull/bear discussions so challenging is that it’s easy to see validity in both arguments with the sinking suspicion that both sides might be proven right, it’s just a matter of when and for how long, which is why the only advice we can offer is to check your fund exposure to know what exactly you’re buying.  Consider CVS Health Corporation (CVS), a stock found in ample quantities in every consumer staples fund but which lagged the rest of the staples category since last July in tandem with the broader healthcare sector due to its fundamental relationship to the healthcare stocks.  Investors concerned about (or looking to add) exposure to healthcare names should check their portfolio carefully and make sure they have the right exposure to the right factors.

Thank you for reading ETF Global Perspectives!

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