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Minyan Mailbag: Reversion to the Mean



Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.

David -

Enjoy your commentary on the 'Ville. I am interested in your general observations about the BBH relative to the QQQQ. On a two-year chart, there obviously was a major decoupling of BBH from QQQQ starting in April05. Obviously, Amgen (AMGN), Genentech (DNA), and Genzyme (GENZ) are big components of the BBH and their respective breakouts during this period contributed to large outperformance of BBH vs. QQQQ since then. I am just wondering if we do get a year-end rally, and given this large recent outperformance of BBH versus QQQQ, if you feel investors will punt biotechs in favor of other techs. I also note the poor price reaction in GENZ and DNA to recent positive earnings news.

Appreciate your thoughts,

Minyan Mark

Mark --

Reversions to the mean are a common occurrence in biotech.

The pattern you describe is likely a product of the rise of zero volatility funds that have shorted dev-stage biotech for their high beta, "beta-matched" long with lower-beta companies, and a sprinkling long of big biotech as a partial hedge. Insofar as that trade continues to be successful, big biotech will have some synthetic support. As (if) short interest in small-cap biotech (NBI) declines, I would expect larger cap biotech (BTK/BBH) to decline along with it as the need to own those companies as a hedge declines.

Two-year chart comparing NBI, BTK, and NASDAQ.

If the landscape for dev-stage biotech I've laid out on the 'Ville comes to pass (acquisition/partnership frenzy), this will contribute to the decline in short interest. If big biotech demonstrates they are participants in the frenzy from the acquisition side, then they'll be further pressured as big biotech is more likely to have to use their equity to compete with big pharma in the acquisition game.

Finally, the latter half of 2000 taught us that big biotech is somehow the flight-to-quality sector for hardcore tech traders. Tech will see gains as we get closer to the Vista launch if the tech magazines suggest hardware upgrades are needed to handle the new OS. If some of the action in big biotech over the last two years was driven by that 2000-era flight-to-quality mentality (which makes me shudder, by the way), then we should see a matching decline in big biotech.

So, there are three reasons I can see for big biotech pulling back to the mean. On the other side of the trade is continued successful trials and drug approvals from the group. Amgen and Abgenix (ABGX) have panitumumab data due any day, Genentech certainly has some Avastin data ready to be presented somewhere, etc.

Hope that helps,


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