#$fbt

Biotech stocks were some of the leaders out of the lows in the market in 2009.  They went on a 6 year tear to the upside after really being flat for many years before the financial crisis.  The Biotech ETF ($IBB) gained 500% over that time period.  Money was made hand over fist trading these stocks.  Every college student wanted to get into the business side.  And then in July 2015 the bottom cracked.  And Biotech started to pull back.

In hindsight it does not seem so unusual to retrace 50% of a move up before a reversal.  Until you put the real numbers on it.  From 80 to 400 back to 240.  And the move down only took 6 months, not 6 years.  But that is all in the past now.  Since that pullback the Biotech ETF has moved in a sideways range for nearly 18 months.  Or has it?  I think I see signs of life.

On a closer review of the chart below we can see that the 200 week SMA stopped the fall and has been acting as support ever since.  2016 saw the ETF trade in a range from 240 to 285.  It broke that range to the upside in August but disappointed many.  It could not follow through to the upside and just established a new slightly higher range from 250 to 300.  Last week saw the ETF back at the top of the range and now reaching the 100 week SMA.  It is stalling as we head into the Ides of March, but has been building solid upside characteristics.

Biotech stocks have had a rough year. Since the July peak in 2015 the Biotech ETF ($IBB) lost about 60% of its value at the bottom. The first 6 months may have been easier for traders to deal with. The trend was clearly down then. But since bouncing in February, the ETF has moved sideways in a channel. It tested the top of the channel in April and fell back. It tested it again in June and failed. Then it tested the channel top again to start this week and has pushed through. Will this third take hold or will it pullback, a failed break out?

The chart below has some indications supporting the run higher continuing. The RSI is bullish and rising. The MACD is also rising. The Bollinger Bands® have turned higher. And the price has moved over the 200 day SMA for the first time since September. The 20 and 50 day SMA's are turned higher following the price.

The only kink in the chart is that the momentum indicators are running hot. They can always get hotter. But the RSI is now technically overbought, over 70. The MACD is also at the peak it saw in July 2015. Often when a break out happens and it gets overbought the price comes back to retest the breakout. 

Many would probably welcome that pullback and retest and they have not bought it just yet. That might be another check mark in the column for a continued price move higher. For now, Biotech Breakout: Take 3 is underway.

The bruised and bloodied Biotech sector is testing a trendline that may determine whether it has one more bull bounce -- or if its bubble has burst.

Today’s Trendline Week feature takes us back to the U.S. to look at one of the, er, trendiest indices in the stock market. After covering Europe on Monday, Japan on Tuesday and back to Europe (specifically, Germany) on Wednesday, today we look at the oft-debated and controversial Biotechnology sector. Bear in mind that we are not picking these markets because of their prominence or popularity, but because they currently offer the most compelling trendline events in the market, in our view. That includes the Biotechs where we see the sector’s premier index testing a crucial level of support.

Like several of the other trendlines we’ve looked at this week, the NYSE Arca Biotechnology Index (BTK) is presently testing the key trendline supporting its post-2008 cyclical bull market.

As the chart illustrates, the trendline in question (drawn on a log scale) originates in November 2008 and connects the lows in March 2009, November/December 2011 and this past February. Again, we have mentioned on several occasions that the increased frequency (i.e., decreased time lapse) of trendline touches is often a harbinger of a forthcoming trendline break. If that is the case here, we can expect to see the trendline give way sooner than later.

On the other hand, we suppose it could be argued that the drop down to the trendline this week was merely a “re-test” of the BTK’s February low. That seems like a stretch to us, but anything is possible. Even if this is a re-test, however, one would expect prices to at least approach the February lows in a closer fashion than they have thus far. That February low sits at around 2575. The recent low in the BTK was 2807, a good 9% above February’s levels. The problem is, the trendline sits right at 2800 today, so a true test of the February low would necessarily violate the trendline, Even if such a breach was temporary, it will still serve to weaken the uptrend.

We mentioned Biotech’s status as “controversial”. By that, we are just referring to the much debated discussion about whether the sector is characterized by a “bubble”. Our thought, based on the parabolic price appreciation and frenzied inflows of investor money it attracted in recent years, was that it was indeed a bubble. The next question is whether the July 2015 peak marked the bubble’s bursting or whether the sector’s got another run to new highs left in it.

Considering it would take a 30%+ rally to get to all-time highs, the sector has its work cut out. Thus, we are guessing that the top is in. However, another leg up can never be ruled out. Some would argue that the post-February action in the sector is a base-building phase that will serve as the launch for that next leg up. That too is possible. However, our view is that cycle patterns would suggest one more wave lower (the third following July-October and December-February) before any substantial rally transpires. Even then, the rally would likely be a counter-trend move that would fall well short of all-time highs.

All that is conjecture at this point, though. If one is looking to play the Biotech sector, long or short, we view the post-2008 Up trendline as an important demarcating line. Hold the line (as it has since its touch on Monday) and immediate upside is more likely. Break below the Up trendline, and another wave lower is probably in the cards.

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The Health Care sector has been one of the strongest performers during the bull market that began in 2009. Being that it provided consistent relative outperformance while also holding a title as a defensive sector gave many investors an increase in confidence in having exposure to this space inside their portfolios. However, recently the performance for health care has begun to decline - notably due to the weakness experienced in the biotech industry.

Below is a weekly chart of the Health Care Select SPDR ETF ($XLV) going back to mid-2009. The setup here is quite simple... In 2010 and 2011 when the equity market as a whole sold-off $XLV found support at its 100-week Moving Average. Currently we have price back to this previously important level of support. Because this is a weekly chart I'm more concerned with where we close on Friday than I am with intra-week price movement.

Each of the prior declines in the Health Care sector were preceded by a bearish divergence in momentum as shown by the dotted lines on the Relative Strength Index (RSI). The selling wasn't strong enough to push the RSI indicator into 'oversold' territory, in fact both instances saw the indicator bottom out around 34. Once again we saw this summer a bearish divergence created as $XLV put in a higher high in price while momentum setup a lower high. Momentum is now back to the level that saw price bottom out in '10 and '11, will the same type of bounce occur here?

Disclaimer: Do not construe anything written here as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the article.

If there must be a poster child for the 6-year cyclical bull market, it is likely the biotech sector. At least that is certainly true for the post-2012 straight up run. The NYSE Arca Biotech Index (BTK) hit an all-time high of 4457 on July 20, up just over 4000 points since its 2008-2009 lows. 3000 of those points have accrued since the start of 2013.

The one problem with bubbly advances like that is beta. Considering the BTK’s gains over the past few years, the ride has been relatively smooth with no closes below its 200-day moving average. However, the pullbacks along the way have been pretty sharp, on an absolute basis. The BTK ran into a 24% pullback in spring 2014 and a 14% pullback this spring. Each time it recovered successfully to yet another new high.

That brings us to the recent decline. At a high to low drop of 24% from July to August, the magnitude of the decline was on par with the 2014 correction. However, this one arguably did more technical damage, with the BTK dropping (well) below its 200-day simple moving average and even forming a lower low below the spring low. This doesn’t mean the biotech bull market is over, but, in our view, the challenges to attaining another new high are more formidable this time. And that challenge should begin in earnest at the fast-approaching level around 4060.

Here’s why we think that.

As the chart shows, several key possible points of resistance lie in the vicinity of 4060, including:

The 61.8% Fibonacci Retracement of the July-August Decline ~4058

The August 19 breakdown level after which the decline began to accelerate ~4048

The 50-Day Simple Moving Average which currently sits ~4065

In our view, this trio of levels should make for tough sledding for the BTK in this area. Of course, within a highly volatile period like the present, some leeway, including a short-term overshoot of the level cannot be dismissed. Thus a temporary spike above this 4060 level that is quickly reversed would not be surprising and would actually reaffirm the area as valid resistance.

And that is not to mention the aftermath of today’s Fed meeting. We have no idea what’s going to come out of it -- or how markets will react. In such circumstances, chart levels on all asset classes anywhere in the world can be rendered impotent in the short-term. Thus, as always, anything is possible.

However, in our view, this level near 4060 should be a stiff challenge for the BTK to quickly overcome. It may be that the index recovers the level at some point down the road, and even moves on to another new high. However, in the shorter-term, this level should present a challenge, particularly if the broader market has more work to do in stabilizing itself in the post-crash period.

Thus, even for biotech bulls, which would include us over the past 12 months, this area may be one to keep an eye on for signs of a struggle.

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While the post-2009 cyclical bull market has yet to run its course, there is a clear leader in the clubhouse in the race for poster child. The biotech sector has been an absolute juggernaut, going on a perhaps unprecedented streak. After leading the way in sector performance the past 2 years with 50% advances, it is on pace to do so again in 2015, up 25% just past the midway point. And while it is almost certainly a developing bubble, it doesn’t look ready to pop just yet.

A telltale sign of relative strength in a market segment can be found in how well it holds up in a broad decline -- and how quickly it recovers. From both of those standpoints, the biotech sector does not appear ready to relinquish its relative strength. Despite its “high-beta” status, the sector held up very well in the recent market pullback, even holding above its June lows. It has also been quick to recover. Before yesterday’s market open we tweeted the following:

@JLyonsFundMgmt   5:22 AM - 13 Jul 2015 Details      

Biotech Index $BTK showing double-top...but could look very Cup-&-Handlish very quickly here...IMO

As of Friday’s close, the NYSE Biotech Index was roughly 3.5% below its highs of both March and June. Of course, for the biotech sector, that’s like a day and a half of trading.

Well, a day and a half later, the BTK is up 3.5% from Friday’s levels and challenging the prior peaks. It is also forming the “handle” of the “cup-and-handle” formation we mentioned.

So what is the significance of a “cup-and-handle”? It is generally a bullish chart pattern that often times leads to explosive moves higher. The gist is that after a relatively long, and normally “rounded” pullback from the original peak, prices return to hit the same level, forming the “cup”. Prices not surprisingly are repelled temporarily by the previous peak levels. However, they return to the peak levels again in relatively short order (the handle). The resiliency in prices to remain near the top of the range is a suggestion that they will eventually break through. Yes, there is a possibility of a triple top in such instances. However, we have found triple tops to be about as common as unicorns.

Importantly, in our view, it is best to wait for prices to break out before jumping aboard, i.e., don’t anticipate the breakout (however, one may not have to wait too long as the BTK is threatening to break out already). What is the upside target upon a breakout of a cup-and-handle? While we are not big on applying targets, there is a general rule of thumb that the upside potential should be roughly equal to the distance from the top to the bottom of the cup. The last time we mentioned a potential cup-and-handle in the biotech sector was in reference to the Biotech SPDR ETF, XBI last October. Indeed, after the XBI broke above the high of the pattern, it went on to double the range of the cup-and-handle, leading up to the March peak.

In the case of the BTK, the range from the top to bottom of the cup would be roughly 600 points (4326-3728). That would target about 14% above the top of the cup here and would bring the index up into the vicinity of the 5000 level which would be a nice round number target (that really isn’t relevant, but would be interesting -- e.g., 2000 Nasdaq bubble top?).

Before we get ahead of ourselves talking about the popping of the biotech bubble, let’s stick with the facts at hand. Those facts continue to be nothing but bullish price action in the biotech sector. For all of the froth and silly money being thrown at the sector, its stocks continue to lead the way higher. And should the Biotech Index break out and hold above the potential cup-and-handle formation, it could run significantly higher still.

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Biotech Sector: Support Levels To Watch

No sector has exemplified these past few years of the cyclical bull market as much as biotechnology stocks. Likewise, no sector has garnered as much attention in terms of speculating on its potential demise as the biotechs have. Therefore, given the immense interest in the space, we thought we’d share some chart levels on the headline NYSE ARCA Biotechnology Index (BTK) that we view as most significant. Additionally, there are a few reasons why this chart is both an instructional one to share as well as one in which we have a good deal of confidence in terms of our read of it.

As you can see from the first chart, we are focusing on Fibonacci Retracement levels in our analysis. When we apply them, we favor calculating the Retracements between the most significant inflection points. And when trading based on these levels, we prefer to do so when there is a confluence of important Fibonacci levels within close proximity of each other. When that is the case, it adds confidence in the validity of the levels.

In the case of the BTK, we measured the Fibonacci Retracements from the major lows in 2011 and 2014 to the recent all-time high in March. The reason we like this chart, and the levels highlighted as significant, is that the Fibonacci Retracements from each of the lows match up precisely with each other. Specifically, these are the key potential support levels as determined by the following Fibonacci Retracements:

3820-3835:

23.6% Fibonacci Retracement of the April 2014 to March 2015 Rally

61.8% Fibonacci Retracement of the February to March Rally

3535:

23.6% Fibonacci Retracement of the 2011 to 2015 Rally

38.2% Fibonacci Retracement of the April 2014 to March 2015 Rally

3050:

38.2% Fibonacci Retracement of the 2011 to 2015 Rally

61.8% Fibonacci Retracement of the April 2014 to March 2015 Rally

2270:

April 2014 Low

61.8% Fibonacci Retracement of the 2011 to 2015 Rally

If you’ve been following the BTK in recent weeks (or today), you may recognize that 3820-3835 level. It is the precise area that has supported the index over the past few weeks, including today. If you were wondering why the biotech sector, which has led the market lower in the past few weeks, was holding up so well today, there’s your answer. The BTK has already reached one level of critical support and it has held, so far.

The fact that the BTK has held so precisely at the ~3830 level that is suggested as important by the Fibonacci Retracments is the other reason why we like this chart so much. And it is the reason why we are fairly confident that the other given levels are also important. When a security  adheres closely -- or “respects” -- a level, it adds validity to that level as well as the successive levels based on the same analysis. Thus, since the BTK has respected the 3830 level thus far, we can have reasonable confidence that, should it eventually break, the BTK will respect the levels below it as well.

Furthermore, witness in the 2nd chart detailing how the BTK has closely respected other Fibonacci levels of late, including:

23.6% Fibonacci Retracement of the April 2014 to March 2015 Rally

61.8% Fibonacci Retracement of the March 2015 Decline

61.8% Fibonacci Retracement of the February to March 2015 Rally

The chart of the Biotech Index (BTK) is an example of one that we would be especially attracted to. It’s not just that the sector is the trendiest on the planet at this point in time. It’s because A) the BTK has closely respected Fibonacci levels recently and B) the Fibonacci Retracement levels from each of the major lows to the recent high precisely match up with each other. Because of those reasons, we have considerable confidence in our read of this chart. Specifically, just as the ~3830 level has proven to be valid as support for the BTK, we are confident that the other levels we’ve listed here will be valid as well.

Keep this post bookmarked -- or keep the levels in mind -- in the event that the Biotech Index breaks the recent support around 3820-3835.

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