The broader stock market has just barely poked its head above the flat line so far 2014. But while most stocks have yet to springboard to new highs, equities have been resilient in bouncing back from a modest selloff in January. Now, investors are trying to determine whether stocks can leapfrog even higher … or if we’ll see another retest of the lows.
However, that story does not apply to every sector of the economy. A couple of areas — namely biotech stocks and solar stocks — have been on a remarkable run for well more than a year now that has translated into triple-digit gains for investors who have stayed the course. These stocks still are breaking out to new highs this week.
So the question now becomes — is this an ideal area to add new money or should you start thinking about scaling back your position size?
Biotech Stocks: iShares NASDAQ Biotechnology ETF (IBB)
The iShares NASDAQ Biotechnology ETF (IBB) — which has more than $5 billion invested across 123 biotech stocks and biopharmas — produced gains of 32% in 2012, 65% in 2013, and has already gained another 20% to start 2014.
Click to Enlarge Biotech stocks are known to be more volatile because of their hit-or-miss business models, which often lead to periods of wild outperformance or underperformance. These stocks can be affected by factors such as FDA approval, drug trials, R&D costs, legal fees and a host other unforeseen events. However, they also can lead to monster profits when new products are developed and successfully tested.
The IBB, which holds stocks such as Biogen (BIIB) and Gilead Sciences (GILD), has truly been on a sky-high adventure that has produced excellent returns for those that got in early. I am hesitant to use the term “bubble” to describe this sector, but it does show signs of valuations becoming stretched and prices hitting extremes. Consider that IBB carried a P/E of more than 40 just a couple weeks ago, which is almost double the iShares Core S&P 500 ETF (IVV) reading of nearly 22.
While volume has remained quite strong this year, I am concerned that those who enter biotech stocks broadly now are going to get stuck with the tab while those who exit reap big profits.
Solar Stocks: Guggenheim Solar ETF (TAN)
Another ETF that has been on a strong 15-month rip higher is the Guggenheim Solar ETF (TAN), which gained more than 125% in 2013 and has already jumped out of the gate with a 30%-plus tear this year.
It’s worth noting that TAN is more concentrated than most ETFs, with exposure to just 29 global companies that are engaged in the production and installation of solar products.
Solar stocks went through a period of excessive declines from 2010-12 that saw them lose a significant portion of their market price. However, this sector has bounced back considerably and has regained its standing as a viable contender for both consumer products and investor interest.
It’s an interesting fact that the largest holding in TAN is SolarCity (SCTY), which just recently hit new life-time highs and whose chairman is Elon Musk. Of course, Musk is most known for his role as chairman and CEO of Tesla Motors (TSLA) which also has produced incredible returns for shareholders over the last two years. Clearly Musk knows how to build solid brands in the clean-energy space.
How you play each of these sectors is largely a function of what your portfolio looks like. If you have exposure to these ETFs or some of their underlying stocks, I would recommend that you continue to hold the positions and ride the trend higher. However, you might want to consider pairing back exposure or trailing your stop-losses higher — that’ll lock in your gains but also guard you against any swift reversals.
For new investors, I would strongly urge you to wait for a pullback before you enter any new holdings. Fast-moving sectors like this can often lead to very swift corrections that offer more opportunistic entry points than buying the highs after a triple-digit move.
I also would add that a trailing stop-loss or sell discipline should be used on any new positions to guard against downside risk.
It’s easy to look at recent performance and deceive yourself into believing that the next two years will look just like the last, but in my experience, these sectors can experience cyclical price trends that make timing paramount to successful trades. Patience and discipline are two sound trading characteristics that will pay large dividends in these sectors over time.
David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. To get more investor insights from FMD Capital, visit their blog.