Biotech buying interest has spread from COVID-focused companies into the rest of the sector in recent weeks, raising the odds that major funds will break out above multi-year resistance and head into strong uptrends. This relative strength should have a beneficial impact on other market groups as well because these issues are components in both small- and large-cap indices, including the Nasdaq 100 and Russell 2000.

The biotech sector has been range bound since reversing in 2015 in reaction to pricing scandals involving Martin Shkreli and Valiant Pharmaceuticals, which is now owned by Bausch Health Companies Inc. (BHC). The United States and European Union threatened heavy regulatory control after the incidents but have done little to constrain the industry in the past five years. And although pharmaceutical pricing was slated as a 2020 campaign issue, the pandemic has forced governments to have a change of heart.

Mid-cap and blue-chip biotech stocks look like sweet spots in this equation, with many underpinned by COVID research. At the same time, small caps look like a stockpicker's market because speculation tends to dry up during market downturns as capital rotates into safer and more liquid securities. This could change after funds break out and head higher, with market players forced to search beyond the big names to find undervalued exposure.

Chart showing the share price performance of the iShares Nasdaq Biotechnology Index Fund ETF (IBB)

The iShares Nasdaq Biotechnology Index Fund ETF (IBB) is built upon a market capitalization-weighted index, meaning that large and mid-sized biotech companies comprise a greater share of the total exposure and pricing. The fund posted an all-time high at $133.58 in July 2015, following a multi-year uptrend, and turned sharply lower in a correction that found support at $80.00 in February 2016.

That marked the lowest low in the past four years, ahead of a basing pattern that persisted into a 2017 breakout above resistance near $100. A modest uptick into August 2018 topped out at the .786 Fibonacci sell-off retracement level at $122, yielding a pullback that failed breakout support before bounding in the first quarter of 2019. This advance stalled at the same retracement level in December 2019, ahead of a decline that held just above the December 2018 low.

A vertical recovery wave set into motion after the March 2020 low, completing a round trip into 18-month resistance in April. The fund then broke out, stalling within four points of 2015 resistance on April 20. It turned higher after testing new support at the .786 breakout on May 1 and now looks set to complete a round trip into the 2015 peak. However, accumulation is lagging strong price action, raising the odds for an extended consolidation phase prior to a healthy breakout.

Chart showing the share price performance of the SPDR S&P Biotech ETF (XBI)

The SPDR S&P Biotech ETF (XBI) is built upon an equal-weighted index, meaning that small-cap, mid-cap, and blue-chip companies are treated equally when computing the total exposure and pricing. The ETF topped out at $91.10 in July 2015 and sold off, dropping to a 20-month low at $44.16 in February 2016. That marked the lowest low in the past five years, ahead of a steady uptick that reached the prior high in January 2018.

The fund broke out immediately, posting an all-time high at $101.55 in June and grinding out a head and shoulders topping pattern that broke to the downside in October. The subsequent decline ended in December at a two-year low, giving way to a bounce that stalled at the .786 Fibonacci sell-off retracement level in March 2019. It cleared that barrier in November, but the rally failed in February 2020, dropping to a three-year low in March.

The subsequent V-shaped pattern reached the prior high on Apr. 27, yielding a pullback into May, followed by a bounce that reached short-term resistance this week. It is now trading just two points under the all-time high and could break out at any time. However, like the other fund, accumulation has failed to match the strong uptick, raising the odds for additional two-sided action before a sustained uptrend sets into motion.

The Bottom Line

Biotech funds are trading close to multi-year resistance, raising the odds for breakouts that could attract substantial 2020 buying interest.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.