US stock markets continue to hesitate while we enter the seasonally weaker part of the year. Small cap stocks have taken a beating, but major market indexes are still close to all time highs. Emerging markets have started to outperform. Does this look like the start of a global bear market to you?
Fear is still low, but confusion runs rather high at the moment. Where to look for clues? This week we will take a look at biotech, my favorite sector for the decade, but let’s start with the Nasdaq chart (click for larger image):
The Nasdaq has been going sideways since early April. My technical indicators are all rather neutral, telling us that the next move can go either way. The Nasdaq has kept up fairly well in the lunar red period that just ended, so the stage is set for a move to the upside in the lunar green period that is getting underway. The question is: can the market do it? A solid climb above 4200 would remove the potential head and shoulders pattern that is worrying some traders. A failure to do so would indicate ongoing weakness and convince traders that the next Nasdaq move will be down. And that would set us up for a drop towards 3600, the long awaited correction that this markets “needs”. I see slightly better odds for the latter scenario, but it is still in the balance at this point.
The biotech sector has outperformed the Nasdaq in recent years, and some people call it a bubble that has burst. I cited biotech as a strong outperform sector for this decade in early 2010 and repeated that call in my forecasts for 2012 (page 23). Is it already over for biotech? I don’t think so. Here is a weekly chart (click for larger image):
The BTK index has tripled since late 2011, before seeing a 20% drop in the recent months. This correction has brought the biotech stocks back to long term trendline support. No up trend has been broken at all. Some people will say this was a parabolic peak, followed by its inevitable implosion. It is just an optical illusion because the chart is in linear scale here. Every long term chart with a linear growth rate will look like a blow-off peak.
Here is a semi-log scale chart of biotech index going back to 1997 (click for larger image):
Do you see any parabolic peak now? We could still get one if the BTK index breaks above 3000 and climbs to 6000+ within a year or two. That’s also what happened to gold after its “parabolic peak” in early 2008, it went on to double again and then it collapsed several years later.
So, be careful if you are seeing a parabolic peak on a chart. Set the chart to semi-log scale and if it still shows an “Eiffel tower” shape then it probably is a parabolic peak. Otherwise you have just been fooled by a linear scale chart.
Most people still underestimate the long term potential of biotechnology. It is like thinking that the computer revolution was over with the introduction of Windows 95. There were some good computer applications already, but the full potential of computer technology was still hard to imagine for most of us. Twenty years from now we may look at biotechnology with the same kind of disbelief: how could we miss such an obvious opportunity. Sure, a lot of biotech stocks have no revenues and no profits, and a lot of them will go bankrupt. But it is quite safe to say that the next Apple or the next Google will be biotech stocks, and they may not even trade on an exchange yet (Google was founded in 1998, three years after Windows 95 saw the daylight). Biologists have only started to study and understand DNA, and the applications will not remain confined to the healthcare sector only. There will be much broader implications with enormous profit potential.