The Truth About Big-Cap Biotech

Click on the chart to enlarge view.

While there is definitely a healthy bottoming pattern forming, it may need more time to develop. Keep in mind, Biotechs have dramatically underperformed the Nasdaq 100 for several years and typically the more damage that is done, the more time that is needed for repair. This is what we're seeing now.

As noted in the Mystery Chart post, there are a lot of positives here including a bullish momentum divergence, improving slope of the 200-day and logical support level to define risk against. While it certainly appears as though a long-term trend reversal is underway, we still need to see prices make a higher high and higher low in the near-term before getting too excited.

Remember, bottoming is a process, not an event.

Now let's put this in context. While Biotechs are trying to carve out a long-term bottom on a relative basis, the Health Care sector appears to be making a short-term top.

Here is a ratio chart of the Large-Cap Health Care Sector SPDR (XLV) vs S&P 500 (SPY) from this week's Top 10 Weekly Charts Report for our Institutional Clients.

In the past day or two prices have violated their former highs at 0.35, confirming the failed breakout and bearish momentum divergence. While anything is possible, it's not likely that Biotechs will be outperforming relative to the broader market in an environment where Health Care, in general, is underperforming.

Now let's look at the absolute chart of the Nasdaq Biotech ETF (IBB).

IBB was one of a very select group of Industry ETFs to recently make new 52-week highs. While the 40% move off March's low is impressive, it's worth noting that momentum could not achieve an overbought reading during this time and now the recent rally looks ready for a breather.

Price is currently consolidating above former resistance turned potential support at key multi-year highs in the 123 area. With a potential bearish momentum divergence at fresh highs, the setup looks strikingly similar to the failed breakout in Health Care vs the S&P 500, above.

What we really want to know is if these new highs are going to stick or not. They absolutely need to if we're going to be bullish on the industry here. The best way to do this is to look at what's going on beneath the surface and analyze the names that are driving the performance.

Luckily, this is a cap-weighted ETF and is very top-heavy which makes our job easy. We'll cover the top 5 holdings below which make up nearly 40% of the index.

Where better to start than with Gilead Sciences (GILD). Not only is Gilead the largest component in IBB at nearly 10% but it is also the poster child and company responsible for much of the recent buzz around Covid-19 treatments.

Investors should really be buying up this name based on the recent news, right?

Not so much... This chart has been a sideways mess for years, and while prices are certainly forming a solid base, the action in this stock has been incredibly choppy of late with vicious whipsaws in both directions.

There is nothing to do here until prices make a sustained move above the significant overhead supply around key multi-year highs in the 85-88 area. As long as we remain below this level, the risk is the downside. There is also headline risk in this name.

Next is another biotech that has been bid up on positive news related to Covid-19 drug development. Here is the 2nd largest IBB component, Regeneron (REGN).

In March, we outlined a bullish trade idea in Regeneron against the 440 level with a price objective near 600. We got a nice move to the upside but prices rolled over in the high 500's, just beneath their all-time highs.

Another ugly bearish momentum divergence as prices run into a logical level of resistance. This is not something we want to be buying here at all.

Here is Amgen (AMGN), which has been one of the Biotech Industry leaders for years now.

Another bearish momentum divergence as price tests potential resistance at former all-time highs and the 261.8% Fibonacci extension. While this is a stronger structural trend than the prior two names, risk is still to the downside at current levels.

Here is the strongest name in the area right now, Vertex (VRTX). We outlined a trade idea in VRTX about a month ago where we only wanted to be long above 246.

Well, it looks like price is about to stop us out and confirm a failed breakout and bearish momentum divergence following the recent all-time highs. The fact that our risk management level is being violated even in leading stocks like VRTX does not bode well for Biotech more broadly.

Last but not least is Biogen (BIIB).

Lower highs and overhead supply. Another sideways mess over a longer timeframe. Hopefully, I sound like a broken record by now.

The point is simple. These are the 5 largest stocks driving the gains in IBB as together they represent almost 40% of total holdings. Despite new highs for the ETF, all of these names are failing at logical levels of resistance right now. Further, most of them are still stuck beneath key prior highs and chopping around in trendless trading ranges.

This means the remaining 60% of holdings really have their work cut out for them if they're going to keep the ETF afloat at current levels. Frankly, it's unlikely they'll be able to do it in an environment where the big-caps we just covered are failing.

The bottom line is if these stocks can't break out to new highs, it's not likely that the Nasdaq Biotech ETF (IBB) will be able to sustain its new highs either. As such, we're anticipating a failed breakout and mean reversion move in IBB right now.

[hide_from accesslevel="premium"]If you enjoyed this post and want access to our premium research, start your 30-day risk-free trial or sign up for our “Free Chart of the Week” to receive more free research like this.

[/hide_from]

Thanks for reading and please let us know if you have any questions!

Allstarcharts Team