Name That Trade – $XBI: Bad Bio Rhythms

by CC October 8, 2015 11:05 am • Commentary

It’s our view that the rolling sell off in U.S. equities that started this past spring / summer in past bull market darlings Apple (AAPL), Disney (DIS), JP Morgan (JPM), Solar Stocks, Tesla (TSLA), Semiconductors, Chinese Internets, Macau Casinos and most recently in Biotechs, is NOT a healthy rotation, but part of a topping process following a protracted bull market.  Of all the stocks/groups listed above, the failure of biotech stocks may be the most useful to extrapolating how the broad market will trade from here on out.  The prior outperformance (the S&P Biotech index, XBI was up 40% at one point on the year, now up just 4%) represented investors’ desperate search for growth during a frenzy of m&a activity. That smacked of a top. I wrote about it in early August, but was a tad late to the entry:

The M&A frenzy in Biotech is unnatural and frankly demonstrates toppy behavior. The XBI, the S&P Biotech etf up 37% on the year, up 75% from its 52 week lows, and only down 9% from the 52 week and all time highs made last month. It looks and feels like an epic short opportunity:

XBI 1yr chart from Bloomberg

Obviously calling a top in a speculative sector like this can and has been a fools errand, but the behavior in the market as it relates to past winners has changed, and the broad market has clearly stalled its bull market gains, made evident by the tight 5% range the SPX has traded in since February.  

The break of the uptrend was the tell. The XBI has since split 3 for 1, and has dropped 35%. It’s my view that a further break at important technical support ($60) could be coming to a theater near you:

[caption id="attachment_57489" align="aligncenter" width="600"]XBI 2 year chart from Bloomberg XBI 2 year chart from Bloomberg[/caption]

Regular readers have heard us say this before (and we are just starting to see this play out now), past market darlings that overshoot on the upside are very likely to do so on the downside. So just like it can be foolish to try to pick a top in a bull market mania in stocks like DIS or TSLA, it can be equally dangerous trying to pick a bottom once the pendulum has swung.

If sentiment towards potential m&a and fears of regulation in drug prices are now the focus, then this momentum shift will take time to play out. That means biotech stocks are shorts on rallies.

The downtrend in the XBI is severe from its all time highs (in mid July), but the etf’s break of the Aug 24th panic low this past week is an even more significant technical event. A press on the short side in the mid to low $60s may be tough, but playing for a break of $60 and a round-trip back towards the 52 week lows near $50 could be in the cards into year end. We will look to enter on bounces higher. The etf opened at $68 just a few trading days ago and quickly sold off over 7 dollars by the next day. So volatility is high and good entries can be rewarding. We’ll be looking to enter on a similar opening, likely with a put spread targeting a break of support at $60.