2018 has gotten off to a roaring start, and biotechnology stocks are no exception. After gaining a market-crushing 43% last year, the SPDR S&P Biotech (ETF) (NYSEARCA:XBI) is up more than 5% so far this year. But will the biotech party rave on? We think it will.
From a fundamental perspective, biotech R&D is very healthy. The number of drugs currently in Phase 2 and Phase 3 trials is on the rise, indicating that many new meds should be brought to market in 2018.
Looking down the road, more biotech and large pharmaceutical companies are backing the development of early-stage drugs as they look to fill their pipelines for the next two to three years. This translates into R&D investments that will provide fundamental tailwinds for these stocks.
Just as important is the regulatory environment that is looking friendlier for biotech companies. The Republican administration and Congress have made no secret of their desire to cut back on onerous rules and regulations, something that has always plagued the biotech sector. Cutting the red tape can only help these companies.
In a change, we’re hearing less rhetoric from the government and the media surrounding end-user prices. In fact, we’ve seen recent examples of high-priced medications defended in the media based on the more transparent benefits these drugs provide. This is clearly a positive for the sector.
XBI ETF Chart
Turning to the charts, we’re seeing a number of positive developments that tell us the biotech rally has legs. First, thanks to a monthlong rally, XBI’s 50-day moving average has resumed its uptrend. This renewed strength suggests that the sector is playing catch-up with the rest of the market.
What’s more, the percentage of component stocks trading above their respective 50-day moving averages is increasing. Such names as Immunomedics, Inc. (NASDAQ:IMMU) and Amgen, Inc. (NASDAQ:AMGN), among others, are breaking into new uptrends that are leading XBI higher. This widening participation indicates growing positive breadth within the sector.
Taking a longer-term view, in February 2016 XBI moved into a bull market that has seen the ETF double in price. As with the intermediate term, an increasing number of component stocks are in long-term bullish patterns, adding positive breadth to the sector.
Another trend we like for biotechs is seen in XBI’s relative strength versus the broader market during the past year. After pulling pack in October and November, XBI has resumed its relative-strength uptrend. Note the surge in relative strength that began last May after a decline.
Finally, we turn to one of our favorite sentiment indicators — short interest. When the shorts are high on a technically strong stock or ETF, it tells us there’s plenty of fuel left to keep the uptrend intact. And that’s what we’re seeing with XBI, which has the highest component-weighted short interest ratio among the widely traded ETFs that we track.
With XBI close to taking out a two-year high, there is a high probability of a short-covering rally (or short squeeze) among many of its component stocks. That should help the sector establish and maintain a leadership role in the market.
Based on a full drug pipeline, an improving regulatory climate, high short interest and strengthening technicals amid a two-year bull run, XBI should continue its market leadership role in 2018. Look for a move to $110 by year’s end, an increase of around 30%.
As of this writing, the Johnson Research Group did not hold a position in any of the aforementioned securities.