Are Large-Cap Biotech Stocks in a Bubble?

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No one likes the “B” word, but it’s worth asking whether we’re seeing one in large-cap biotech stocks right now.

biotech-stocks

Source: ©iStock.com/AlexRaths

At first glance, it seems to be a legitimate question given how well the sector has performed in the past year. The iShares Nasdaq Biotechnology Index (ETF) (NASDAQ:IBB) has gained nearly 70% since the low of mid-April 2014, and it has done so without a major correction. In the year-to-date period alone, IBB has gained over 20%.

Its largest peers, the SPDR S&P Biotech (ETF) (NYSEARCA:XBI) and the First Trust NYSE Arca Biotechnology Index Fund (NYSEARCA:FBT), have gained 27.6% and 23.5% year-to-date.

This type of performance may indicate some froth, but not a bubble – at least among the sectors four giants. Based on their valuations and growth outlooks, the prerequisites for a biotech bubble simply aren’t in place.

The table below shows the key valuation metrics for the big four biotech mega-caps — Biogen Idec Inc (NASDAQ:BIIB), Celgene Corporation (NASDAQ:CELG), Gilead Sciences, Inc. (NASDAQ:GILD) and Amgen, Inc. (NASDAQ:AMGN) — are no longer cheap, but they aren’t unreasonable relative to the companies’ growth prospects.

biib celg gild amgn table 1

At these levels, these stocks still have plenty of room for potential upside despite the huge gains that are already in the books. Perhaps more important, these valuations provide a measure of protection in the event the overall sector experiences a correction.

In this sense, talk of a bubble simply doesn’t apply here. Instead, it represents yet another example of investors’ hunt for the next financial asset to collapse in the post-financial crisis world. Remember the “bond bubble” of 2013, which never quite panned out as expected? Ultimately, it takes more than strong past performance to create a true bubble.

Other Drivers for Biotech Stocks

There’s more to the case for large-cap biotech stocks than just growth and valuations. The sector also offers a larger macro play that may be as much of a catalyst for outperformance as the stocks’ individual traits.

At a time of weak global growth, few industries have the potential to deliver growth that is relatively independent of the broader economy. Biotechnology, in particular, stands out for its ability to excel without an economic tailwind. This factor has acted as a source of demand for the sector not just recently, but over the longer term as well. Since the market low of March 9, 2009, IBB has gained 514%, more than double the 250% gain for the SPDR S&P 500 ETF Trust (NYSEARCA:SPY).

As long as the global economy remains sluggish, expect continued demand for the type of “secular growth stories” that can be found in large-cap biotech stocks.

IBB, 10-Year Chart

Source: bigcharts.com

IBB, 10-year chart

Biotech stocks have also demonstrated the ability to withstand adverse headlines. So far this year, both GILD and AMGN have taken hits on concerns about competitive pressures, and both managed to rebound in a matter of days. As long as the market can continue to overlook bad news, the uptrend can remain intact.

One potential issue that investors need to monitor is the direction of earnings estimates. As shown in the table below, estimates have flattened out for all the major biotech stocks but BIIB during the past 90 days. If estimates begin to roll over and turn lower for the sector’s mega-caps, it will be difficult for the overall group to maintain its momentum. Keep a close eye on these numbers in the weeks ahead.

biib celg gild amgn table 2

In terms of timing, it’s imprudent to chase biotechs higher right now given the price action of the past month. No matter how strong a group may be fundamentally, investors need to be conscious of technicals. In this case, the fact that IBB’s Relative Strength Index, or RSI, is at peak levels should be a reason for caution. Further, IBB is currently trading at a whopping 22.2% above its 200-day moving average.

This doesn’t mean it’s time to short biotechs, though. Biogen’s jump this morning, which occurred in the wake of the release of positive data on its Alzheimer’s treatment, indicates the perils of betting against this news-sensitive sector. However, the technical factors indicate that the best approach is to wait for a pullback before jumping in.

Bottom Line

Biotech stocks are indeed frothy, but talk of a bubble is premature — at least when it comes to the sector’s Big Four mega-caps. While there’s no rush to buy at these levels, there’s also no reason to be afraid of buying the big-name biotechs on a dip.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/03/large-cap-stocks-bubble-amgn-biib-gild-celg-ibb/.

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