• Biotech stocks are currently lagging with very weak technicals.
• The current earnings cycle is pivotal to market sector direction.
• Small/mid-caps need to lead the way.

If you have been reading our recent posts, you may have seen that biotech stocks have been in a funk lately. The IBB has broken through the SMA-200 support line near $160 and it holds a perilous perch at $155, up only about 2.5% year-to-date. The IBB has been down over 10% for the past 30 days, correlating with many analysts' warnings about a September and October correction.

Even the most stable healthcare ETF, the XLV, is 20 points off its highs. However, it is still up 11.4% year-to-date as it has been bolstered by United Health (UNH), which reports on Thursday, Oct. 14.

Healthcare has been one of the leading sectors of the market, as it was up 11% in 2020, but it has been weakening a bit lately. Healthcare stocks provide defensive growth with dividends from large-caps.

But even many large-cap biopharmas are way off their 52-week highs. Here are several that have been holding up within 20% of their respective 52-week highs: AbbVie (ABBV), AstraZeneca (AZN), Gilead (GILD), GlaxoSmithKline (GSK), Eli & Lily (LLY), Merck (MRK), Pfizer (PFE), and Roche (RHHBY).

But we are now in the midst of a potential re-rotation into cyclical stocks and away from momentum plays, which is characteristic of the small- and mid-cap biotech sector. The leading sectors over the past week are: energy (the XLE has been up 18% over six months), financials, and industrials. When combined with current supply chain disruptions, energy and materials strength may lead to inflation concerns, possibly even stagflation worries.

Our model healthcare portfolio has served us well as it comes up on its one-year anniversary since its inception. But the IBB weakness poses a rebalancing issue, as there appears to be a sector shift out of growth and momentum into cyclicals and value. This trend shows the importance of a diversified portfolio because of potential changes in the economy.

Small- & Mid-Caps Need to Lead the Way

Note that the IWM position has done well, as it is up 13 % year-to-date, and small-cap strength should continue if the US economy does well. But the small-cap weighted XBI is down over 12% year-to-date, having peaked in February 2021. Until the XBI shows momentum, small-cap biotechs are a risky trade because they are generally overvalued and not supported by fundamentals.

in addition to the Russell ETFs, we own the (IJR) iShares S&P Small-Cap ETF, which has been stalled since June. Most of our speculative biotechs are down, except for the focus stocks we have covered: CRSP, CYRX, QDEL, and VIAC, which also were down the last two weeks.

Over the past year, we have updated the model to include a Medtech position, such as the iShares U.S. Medical Device (IHI). Our best picks for mutual funds are the T.Rowe Price Health Sciences Fund (PRHSX) and the Fidelity Select Medical Technology (FSMEX) Portfolio.