If you think the S&P 500
(INDEXSP:.INX) is in a bubble, then looking at the the biotech sector will make you sick.
The S&P is 181% above its March 2009 low, which sounds impressive -- but compared to biotech, that's nothing!
Over the same time period, the Nasdaq Biotechnology Index
(INDEXNASDAQ:NBI) has risen an incredible 316%.
However, a certain question is on everyone's mind, and we can illustrate it with a simple Google
(NASDAQ:GOOG) News search:
Everyone wants to know -- is biotech in a bubble?
The sector rose 98% from the start of 2013 to the top on February 25, 2015, at which point the index dropped a quick 12%.
Of course, it didn't help that biotech giant Gilead
(NASDAQ:GILD) recently received a letter
from Congress inquiring about the price of the company's Sovaldi hepatitis C drug, spurring concerns about price controls.
So is this the beginning of the end for biotech?
Or a mere bump in the road?
Drug price controls are unlikely in the near future.
Medicare and Medicaid can't negotiate drug prices in most cases, and the federal government has no power to simply order the price of Sovaldi lower.
Additionally, the biotech sector started declining well ahead of the Sovaldi "news," along with other momentum groups like fuel cells, cannabis, and social media.
With no real sign of a deterioration in sector fundamentals, the action looks like profit-taking after a huge rally -- not the end of the world.
One option for the long side is the iShares Nasdaq Biotechnology Index ETF (NASDAQ:IBB), which provides exposure to a wide variety of biotech names, including Amgen (NASDAQ:AMGN), Biogen Idec (NASDAQ:BIIB), and the aforementioned Gilead.
Biotech has had a great run over the past few years. After a 300%+ move in five years, we're in all likelihood way closer to a top than a bottom.
Even with a 12% decline off the top, the sector's still overheated, with stratospheric valuations amid a streak of outperformance that can't last forever.
Additionally, even if Congress really has no power to institute price controls, the risk isn't off the table longer term, and there's no telling how badly that could impact sentiment toward the sector. That means lower valuations and a disruption in the red-hot IPO market.
A high-risk way to profit from an extended biotech slump is to short the SPDR S&P Biotech ETF
(NYSEARCA:XBI). Relative to IBB, XBI has greater leverage to smaller, more volatile names. In a broad sector downtrend, that could mean more downside potential.
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No positions in stocks mentioned.
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