Namely, the Biotech sector within the wider stock market.
Is the wider stock market in a bubble? Valuations in the 97th percentile, record extreme leverage, allocations second only to the dot.com bubble, all time record cluster of readings in sentiment, and more. Bubble deniers point to the context of ZIRP and QE as this time it’s different. Or they argue the froth we are seeing is of a new secular bull, with the stock market leading the economy. But ‘this time is different’ has rarely worked out historically and there have been many indicators acting like they did at the peak in 2000 or 2007, which I have published on the site in recent months. Here’s one:
That surge in unprofitable IPOs looks a lot like 2000, and whilst then it was particularly concentrated in dot.com companies, this time round there is a lot of Biotech.
As we all know, into the dot.com peak of 2000, the mantra was that traditional valuations didn’t apply any more, and that stocks were ‘revalued’ on potential and expectations, justifying the crazy prices. Ultimately, traditonal valuation methods did still apply, and the pop was fairly unforgiving.
Today’s Biotech bubble is the same. Take a look at the constituents of the Nasdaq biotech index:
Just a handful of companies are making any money and the vast majority none or a loss.
Now look at how Biotech has outperformed the wider markets:
And see how that run up in price has been solely multiple expansion, i.e. valuation rising hand in hand with price:
The price to sales ratio in Biotech is now over 10. Compare that to the SP500 which is around 1.8, which in itself is at the very top end of its historic range and close to the 2000 peak.
We can all see the parabolic, and we all know how parabolics end.
IBB is the vehicle that mirrors the Nasdaq Biotech index.
I want to short Biotech. But we have to be careful with a parabolic because they can steepen further before collapsing. So do we know when the game is up? One is a technical breakdown. Here’s how the Shanghai Composite looks today:
It broke mid-June. There was a divergence in strength leading into the peak, and there is such a divergence on the current Biotech chart.
The other clue is the wider market.
Source: John Kicklighter
The last couple of days delivered another telling bearish reversal. Those negative divergences are all still in tact. We await the news on Greece and whether some kind of deal announcement would pump the markets back up again in the short term. So whilst I’m looking for short entries on Biotech and Russell 2000, the timing has to be careful. Plus, it will be a little at first, then building up. That building up may happen swiftly, as when Biotech breaks there are reasonable odds it will be quickly ugly.
If you have been long Biotech then sincere congratulations. It’s been the trade of the decade so far. But I would equally expect that short Biotech will be the trade of the next couple of years. It’s going to be about nimble and accurate timing and attacking. Will let you know when I enter.