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Beware the Parabolic Curve in Biotech


Biotech stocks outperformed the market during the 2008 financial crisis. In late 2011, something changed: Loose money piled in.

Money printing: It can stabilize things for a bit.

There seems to be two camps regarding bubbles and market dislocations. Some think that bubbles are a symptom of capitalism and greed run amok. And, sure, any good bubble needs some greed and stupidity. However, if anything, the main culprit in our recent bubbles has been loose monetary policy.

The policy makers at the Fed seem to be scared out of their wits about the potential for another Great Depression, so they keep flooding the system with liquidity every time there is a hint of a downturn in the economy or a slight threat of deflation. But when you use loose monetary policy or money printing as tools, there are unintended consequences. In the late '90s, it was a massive bubble in technology and especially Internet stocks. In the mid 2000s it was a real estate bubble -- not only in the United States, but in Western Europe and in many other places in the Western world (Spain and England come to mind). In the first part of the reflation from 2008 to 2011, many commodities experienced mini bubbles.

Over the last few years the money printed seems to have flown back into the technology sector. It is also no coincidence that since the Fed upped the ante by printing nearly $85 billion a month since November 2012, many of technology sub-sectors have seen the rate of their gains increase tremendously.

Many now have the dreaded parabolic, or hockey-stick, chart -- the type of chart whose line runs straight up, with the trend line putting in a near 90-degree angle.

These type of charts are totally unsustainable and usually end in horrific crashes. One of the first parabolic charts was the Dow Jones Industrial Average (INDEXDJX:.DJI) of the late '20s, which ended in the 1929 to 1932 meltdown.

Gold went parabolic in the late seventies and fell nearly 70% from its 1980 high to 1982 low. When the Nasdaq (INDEXNASDAQ:.IXIC) went parabolic in the late nineties, it fell nearly 80% from its 2000 top to 2002 low.

The current parabolic sector is biotech.

After crashing along with the rest of tech in 2000, biotech stocks began a very mild bull market ride from about 2003 to 2011. They even outperformed the market during the 2008 financial crisis. However something changed in late 2011 as loose money was looking for new sectors to go into it. It found biotech.

Since hitting a low of $83 in mid 2011, the iShares Biotech ETF (NASDAQ:IBB) has nearly tripled in a little over two years to $264 per share.

Below is a chart of the IBB, which now has reached the classic parabolic blow-off. Now no one knows when this madness will end; the IBB could go to 280, 300 before topping. However, it is now so parabolic and so straight up that it is probably in the final stages of its bull market.

And here is the bad news: Usually with bubbles of this nature, it's not just a 20% correction and back to new highs. As stated earlier, these bubbles are usually followed by vicious multiyear bear markets that take the sector down 60-70%, or even 80% or more.

The roller coaster is a lot bumpier and scarier on the way down than on the way up.
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