Biotech Funds Could Generate Profitable Short Sales

Major biotechnology funds have reached resistance levels that could yield major reversals and steep retracements that test impressive first quarter gains. Well-timed short sales could profit during this downturn, taking advantage of broad complacency that has characterized 2019 price action. It's even possible that recent highs will mark starting points for much steeper declines that complete long-term topping patterns.

The Federal Reserve has reversed gears on interest rate policy, raising speculation that governors are worried about underlying weakness that could drop the U.S. economy into a recession. There's little evidence of a downturn in recent data, but that could change given the failure of the U.S. and China to cut a trade deal by the March deadline. Biotech stocks could get sold aggressively if the economy contracts and over-leveraged shareholders are forced to free up cash.

In addition, there's actually little disagreement between warring political parties about the need to control rising pharmaceutical costs, through legislation if needed. The subject is destined to find its way into 2020 political platforms like it did in 2016, keeping pressure on the biotech industry. And while bad memories of Martin Shkreli and Valeant Pharmaceuticals are starting to fade, new industry villains are likely to emerge between now and the presidential election.

The SPDR S&P Biotech ETF (XBI) came public in the mid-teens in February 2006 and entered a trading range with support at $14 and resistance at $23. It broke out in 2010, entering a powerful advance that posted a long series of higher highs and higher lows into the July 2015 peak at $91.10. The fund sold off into the mid-$40s in the following six months, reaching a 20-month low in the first quarter of 2016.

A slow and steady uptick completed a round trip into the 2015 high in October 2017, ahead of a February 2018 breakout that attracted little buying interest. The breakout failed in October, signaling a steep decline that posted a 22-month low in December. XBI has bounced strongly since that time, recouping more than 70% of the downturn, but it has now reached new resistance at the failed breakout level.

A final uptick could stretch into the .786 Fibonacci retracement level at $94, which has aligned with the breakdown from a five-month topping pattern. The first pullback to new resistance sets off a textbook short sale signal, but a strong stomach will be needed, at least until a reversal is confirmed with a breakdown through the 50-week exponential moving average (EMA) at $85. Meanwhile, the weekly stochastics oscillator has crossed into a sell cycle while accumulation readings are slumping near corrective lows, generating additional bearish headwinds.

The iShares Nasdaq Biotechnology ETF (IBB) sprang to life in the low $30s in February 2001 and topped out at $36.43 just four months later. It sold off to an all-time low at $13.22 in July 2002, rounding out a trading range that held intact into a 2012 breakout and uptrend. The fund posted impressive gains into July 2015's all-time high at $133.58 and turned sharply lower into the first quarter of 2016, finally bottoming out at $80.

A shallow but persistent uptick reversed at the .786 Fibonacci retracement level of the 2015 into 2016 downtrend in August 2018, giving way to a steep decline that found support just nine points above the 2016 low in December. The fund bounced strongly in the first quarter but has now stalled at the .786 retracement level of the 2018 downturn. Matching ratios between sell-offs may signal the start of a steep downturn that has the power to break the 2016 low. Like its rival, IBB has also flipped into a stochastics sell cycle while accumulation has barely budged off the December low.

The Bottom Line

Biotech funds have reached major resistance levels after low-volume rallies, raising the odds for reversals that benefit timely short sales.

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