Four statistics for biotech ahead of Yellen's semi-annual testimony

Monday, 23-February-2015

Federal Reserve Chairwoman Janet Yellen is scheduled to give her semi-annual economic update to Congress on Tuesday and Wednesday (February 24 & 25).  This is the same occasion where she used the term "substantially stretched" to describe social media and biotechnology stock valuations last July.  Given the way those comments temporarily moved markets, traders would be smart to at least consider the possibility that something similar could happen again.  As I mentioned in a preview to this event two weeks ago, there are a couple of directions she can go with this.  Ms. Yellen can obviously say nothing, perhaps acknowledging that it was a mistake to single out sectors of the economy like that in the first place, or she can go the opposite route and double down on her warning to be consistent.  While I think the latter option is a long shot, it is an investor's job to always consider the worst case scenario in life.  With that in mind, I have put together the below infographic to illustrate how red hot the biotech market still is today - seven months after her comments.  The question is this: if Ms. Yellen thought, right or wrong, that things were stretched back then, what must she be thinking now?

In my opinion, the real whopper of a statistic on the infographic is the 45.6% gain for the SPDR S&P Biotech ETF (NYSE: XBI) since her July comment.  The XBI is the biotech index that most closely tracks smaller and mid cap stocks.  In other words, the very stocks Ms. Yellen flagged as being "substantially stretched" are now 45.6% higher today!

 

That disconnect is the reason why I think there is at least an outside chance she might bring the issue up again, perhaps with even stronger words this time.  Think about it, how can you call a valuation "substantially stretched" yet not say anything when the same assets are 45.6% higher seven months later?  If Ms. Yellen truly thought those valuations were high back then, she might think they are outright obscene now.  While I personally think it was a regrettable mistake for her to have brought this up in the first place, it is at least worth considering that it could happen again based on those numbers.  It is a low probability event, but one you should be aware of.

 

Biotech returns year-to-date for 2015 might be a little too hot

 

My personal opinion is that this multi-year bull run in biotech is legitimate.  With new technologies like cancer immunotherapy, gene therapy, and RNAi coming around the corner, there has never been a time of more exciting innovation.  It is going to take a failure of one of those cornerstone technologies that everyone is betting on to derail this market in a significant way.  Also, consider that the industry has substantial demographic shifts working in its favor.  Global healthcare spending will likely double over the next ten years, and it is fundamental factors like that being reflected in these stocks.

 

With that being said, I am now concerned about what a huge start biotech stocks have gotten off to in 2015.  As the below chart shows, both the iShares Nasdaq Biotech ETF (Nasdaq: IBB), which is weighted towards larger biotech stocks, and the above mentioned XBI are both sporting double-digit percentage gains already.  This is happening while the broader market indices are struggling at around 2%.

Personally, I think these returns might be a little too hot, and are likely based on conference hype (both the JP Morgan Healthcare Conference and BIO CEO happen early in the year, two big ones) rather than actual fundamentals.  As much as I like making money, I wouldn't complain if biotech at least took a small pause for a while.  Hopefully it won't get much worse than that.

 

This weekend I tweeted out the above chart and asked if investors thought the sector could keep it up, or if we are due for some turbulence ahead.  I highly recommend checking out the entire discussion, which is excellent and numbered over 100 comments, but here are a few responses that were especially popular: