Biotech Stocks Face a Steep Drop

(Note: The author of this fundamental analysis is a financial writer and portfolio manager. He and his client's own shares of CELG.)

Despite having a rollercoaster start to the year, biotech stocks have had a solid start, with the SPDR S&P Biotech ETF (XBI) up by over 5%, versus an S&P 500 that is flat on the year. But the group has struggled of late, and the ETF is down over 8% from its high in the middle of March while the sector is struggling to find leadership.

An analysis of the ETF's chart suggests the biotech sector could be set for a decline of over 8% from its current level around $89. That means the ETF could be facing a decline of over 16% from its peak of $98 in the middle of March. (For more, see also: Top 5 Biotech Stocks for 2018.)

XBI Chart

XBI data by YCharts

Double Top 

The chart shows an ETF that has been struggling to find its footing and has been trending lower for over a month now. Additionally, a double top pattern may have been established with the ETF reaching a price of roughly $98 two times, once in late January, and a second time in mid-March. The pattern is a bearish reversal and means the ETF could be facing a much steeper drop. Confirmation of the double top pattern would occur should the price fall below support at $82, a drop of about 8% from its current price around $89.

Weak Relative Strength

The chart also shows that the relative strength index (RSI) is trending lower as well, and has yet to reach oversold conditions with the RSI reading currently at 49. The ETF will reach an oversold level if it falls to 30 or below. The RSI also suggests that more declines are likely in store for the ETF and the group. (For related reading, see also: Biotech Stocks Near Massive Breakout)

Old Guard Struggles

Of the top 25 holdings that make up the Biotech ETF, only 11 are up on the year, while 14 are lower, with an average return of 1.2%, based on data from YCharts. Leadership has been missing from the biotech sector from the most prominent biotech's Celgene Corp. (CELG), Biogen Inc. (BIIB) and Amgen Inc. (AMGN) all down on the year. Each company has struggled in recent years to reignite their growth engines, with revenue stagnating and the market assigning them low earnings multiples to reflect the stagnating growth.

CELG PE Ratio (Forward 1y) Chart

CELG PE Ratio (Forward 1y) data by YCharts

New Leadership

A new group of younger and smaller companies has attempted to pick up some of the slack, with shares of Spark Therapeutics Inc. (ONCE), Agios Pharmaceuticals Inc. (AGIO) and Sarepta Therapeutics Inc. (SRPT) up by over 40% on the year. But with the absence of the big biotechs, the group is going to need additional smaller companies to pick up the slack. 

The outlook of the biotech group looks weak based on the technical chart, while leadership is lacking, and that may make it tough for the sector to build up any positive momentum. 

Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the founder of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of two to three years. Click here for Kramer's bio and his portfolio's holdingsInformation presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.Upon request, the advisor will provide a list of all recommendation made during the past twelve months. Past performance is not indicative of future performance.

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