As the stock market recovers from the Covid-19 crash, the headlines have been more positive than fearful of late. Most often the fuel comes from positive updates on vaccine progress. It’s no surprise that the biotech stocks broke out into all time highs. Year-to-date the iShares Nasdaq Biotechnology ETF (NASDAQ:IBB) was up as much as 10%. It is important to note that tech and the IBB were red on Tuesday while the Dow Jones and the S&P 500 rose 2% and 1% respectively.
Yesterday investors rotated out of what had been working like the IBB, Netflix (NASDAQ:NFLX), and Nvidia (NASDAQ:NVDA). In exchange, they piled into small-caps, banks, and travel and leisure.
The risk for those still chasing biotech stocks is that this rotation may persist. This is not a knock against the fundamentals. Sometimes Wall Street goes on binges then flips into a different direction.
There Is Too Much Hope in Biotech Stocks
Meanwhile, what is clear to me is that the bulls are unwilling to let go of hope. This is a trickle-down effect, because none of the high-profile experts in the media ever mention the possibility of a vaccine failure. Case in point — the CEO of Merck (NYSE:MRK) stated that they had “reasonable degree of confidence” they will succeed … but maybe not this year. This could end up being false hope but only time will tell and therein lies part of the concern.
Success from investing in biotech stocks will come down to timing, and now is not a clear point of entry into them. I suspect that there’s too much hope about the second half of this year. The upside momentum may have run its course, and much like with the Nasdaq, they should not make new highs under these horrific macroeconomic conditions.
Yes, the government stimulus packages help but this is a bailout of epic proportions. They don’t usually do this unless there’s something seriously wrong with the economy.
Patients usually don’t celebrate because they are getting extremely strong medicines. The need for such medicine is proof that the economy is seriously ill. At least this depression was self-inflicted and the decision has already started to reverse the process. But the recovery is not yet guaranteed. Consequently, conviction needs to be more humble than it actually is. This is especially true in the biotech and healthcare sectors.
Doing What Hasn’t Been Done Before Is Not Easy
Companies working on vaccines are trying to accomplish what has so far been impossible. This vaccine would be the first of its kind and for many companies in the race like Novavax (NASDAQ:NVAX) for example, this will be their first success ever. Yet the debates in the headlines are to “when” we will have a vaccine but not “if.” We are lacking some realism because the status quo is that it’s never been done before so onus is on biotech companies to prove otherwise.
Shorting IBB stock at this top is a viable trading strategy. The spirit of it is a bit macabre, because in essence, investors would be betting against the well-being of others. But this is a business write up that looks for opportunities.
To say this in a more positive way, I would suggest to book profits for those who have been long the IBB from the bottom. The ride has been incredible and the profits are real. Starting new longs from this level is vulnerable to disappointment.
The fundamentals of these companies are not the scary part. These are headline stocks so they move in giant bursts in either directions based on findings not on what their P&L currently says. The top 10 companies in the IBB include Gilead (NASDAQ:GILD), Biogen (NASDAQ:BIIB) and Moderna (NASDAQ:MRNA) encompass almost half of the ETF and they tend to trade as one unit. A disappointment in one affects the collective in sympathy. Trading other ETF’s usually diffuses the threat of a single stock headline but in the IBB it’s the opposite.
The Buyers Are in Charge and They Will Buy the Dips
There are also technical reasons to suspect that biotech stocks will face sellers up here. Even though the IBB set new highs it failed very close to the same spot as 2015. The naysayers are likely to start propagating the idea of a tremendous double top.
Short-term charts suggest to either chase IBB after it breaks out from $136 per share, or buy the dip near $120. I also expect some interim support near $127. So far it has been setting higher-lows so the buyers are in charge and they will buy the dips when they happen. The zone around $120 has been pivotal for almost five years, so it should lend support on the way down.
These levels are independent of the vaccine headlines. A serious disappointment there could cause a bigger correction than what is evident now. This is not new for biotech stocks, as they have always been notoriously susceptible to headlines.
Conviction in either direction should be low. Nothing rises forever without rest, so being bearish for a period of time on a group of stocks is normal. Dips are necessary to build a better base of owners for the next leg higher.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. Join his live chat room for free here.