Mar 24, 2014 - Biotech harbinger?

For the past 3 years, biotech stocks have been the darlings of the market. The compelling stories they present having the potential to solve the maladies and genetic imperfections of the human race have brought immense amounts of money into this sector. The chart below shows just over the past 3 years (through February of this year), biotech stocks have outperformed the SP500 index by more than 90%. That is an astonishing ~25%/year compounded differential.

One of the interesting back stories in the markets this week was the bearish action in Biotech stocks. While the SP500 index was making new all-time intraday highs (but failed to keep it at the close), biotech stocks were experiencing their biggest decline in a year. We all understand declines are a normal part of the markets ebb and flow and biotech’s have experienced their share.  Over the past 3 years Biotech’s worst year selloff’s have been; 2011 = ~ -24%, 2012 = ~ -16%, 2013 = ~ -12% . You can see that each year the selloff has gotten smaller and smaller which underscores their strength as investors jumped at the buying opportunity more aggressively each time they had the chance.

Last month’s beginning of the selloff was not much of a surprise as we had plenty of warning. You can see in the chart below we printed a divergent high (prices are rising while momentum is falling) on the 25th of Feb as we did in last year’s October sell off. In addition to that warning flag, when looking closer at the Feb 25th close, we formed a hanging man candlestick which was the confirmation that a (temporary) top was in and we should expect a change in direction. So far the 2014 decline has been ~11%. While we have broken the up-trending support line, we sit right on the 50dma which may be all this current decline needs to stop. If not, a logical next stop would first be 235 followed by 225.  If the market really gets going to the downside, major support exists at the 200dma which right now is at 215.

 What is especially interesting is looking at past selloffs over the last 3 years biotech stocks either coincided exactly with the timing of or lagged slightly behind the broader SP500 index.  This time it is leading. This, combined with divergent highs on the index, the bearish shooting star candlestick close on Friday, the huge increase in volume and the lack of near term support levels, I fully expect to see a few more bears come out of hibernation this next week.  The first question one must ask is if Friday's sell off is creating a major buying opportunity or the even bigger question is if not how long can the strongest sector of the index continue to fall until it begins to have a negative effect on the overall market and pull it down along with it?