This year has been a tough year in general…certainly not one of those +170% years I got lucky enough to experience over the past 6 years. I’ve reserved myself to this possibility from the start of the year, trying my best to keep myself from taking too many risks. The downside to this is that if I’m wrong and we have a tremendous run from here, then I will be missing out on significant upside gains. But having been on such a good run, the goal now is to preserve as much of those gains as possible and still participate in the upside somehow.
Lately I’ve been eying up the potential for a substantial correction in biotech stocks in the fall, thinking that they might have one last run in them…a potential blowoff top coming in the late summer. First, its important to realize that nailing down the timing of blowoff tops is nearly impossible (and spending a significant amount of time watching the overall market is oftentimes just a waste of time…you’re usually better suited searching for cheap individual stocks). Just ask all of the people shorting the Nasdaq in the fall of 1999 (although I was still in college then I’ve read that there were plenty of skeptics then and the bull market just bulldozed over them) as it rallied almost 100% in the last 6 months of that epic bull market.
The Biotech sector has been on a similar epic bull run. Below are the returns for $IBB, an exchange traded fund (ETF) for the biotech index, over the past several years:
As you can see, it has generated returns of 418.06% from the close of 12/31/08 to 6/11/15 and 523.73% from the lows on 3/9/09.
By comparison, the only bubble I can find that is close in terms of total returns is the 1995-1999 Nasdaq bubble, which generated returns of 441.21% over that time period. This bubble occurred over a shorter time period (5 years vs 6.5 years for Biotechs) so the resulting crash was most likely more severe than what we should inevitably see with biotechs – i.e., violent rallies often end in violent corrections. Returns for the Nasdaq during that time period are listed below (I included the subsequent 3 years to see what the bubble resulted in):
In addition to this similarity, I’ve been casually watching the similarity in chart patterns of the current biotech bubble with the 1987 stock market, another stock market bubble. The early 1980’s bull market was an impressive bull market as well, with the S&P 500 seeing a roughly 240% rise from August 1982 lows to the peak in August 1987. Take a look at these chart similarities (the chart on the left only takes into account trading through mid May 2015 for the Biotech ETF (Symbol: $IBB). Biotechs has since risen from $355 to $368 over the past 3 weeks.). They actually line up fairly close, with biotechs currently on the verge of breaking out to new highs after a mini blowoff top in March, much like the S&P 500 did in June 1987 after a mini blowoff top in March of that year. See the charts below:
Given how most market or sector meltdowns tend to occur around September/October, I’ll be on the lookout for a potential blowoff top in biotechs sometime in July or August, then a meager attempt to rally back to the highs, with a subsequent meaningful (20%+) drop in the biotech sector. If this does transform, I’ll be looking to buy BIS heading into July/August.
If this was to happen, I’m not sure what impact this will have on the overall market. My suspicion is we might see a 10 to 15% drop. But whatever transpires, I will be looking to substantially reduce my risk heading into next month. Having said that, I do really like one sector which I plan to write about more in the future: solar. I haven’t yet taken positions in this space but I’m hoping to do so on a market pullback.