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Biotech ETF Initiation Report

Biotech ETF (XBI)

Several stocks in the Nasdaq biotech index are what Ben Graham would call net-net stocks, meaning the market cap is below current assets less all outstanding liabilities. Biotech companies are like burning matches - they keep raising cash and spending it on research, hoping they can get a drug through the FDA trials or get acquired by a pharma company at a premium. The high interest rate environment dried up funding for biotech research, and investors lost interest in the sector as a whole.

However, several fund managers have started taking an interest in biotech stocks this year (see daily chart below), and the momentum players have caught on to the opportunity as well. There's a great fundamental story to it, especially as the miracle drug Ozempic is making daily news. This space is making a comeback.

XBI daily chart

I've chosen XBI over iShares Biotech ETF (IBB) because XBI provides broader exposure. IBB is more concentrated. This shows in the YTD performance of the two ETFs, with XBI down 0.76% while IBB is down 2.17%.

On the daily and weekly XBI charts, glance at the two indicators at the bottom. BBW stands for Bollinger Band Width. On the weekly, note how the width went from a long, low base to start an uptrend recently, while on the daily the width expanded, formed a rounded top and came back down. BBW is a volatility indicator - you want to see volatility go up when a security emerges from a consolidation phase, which is what you see on the weekly chart. Note how the weekly closes are holding steadily above the 2023 Jan and June peaks. This is a sign the consolidation/trendless phase is over and XBI will leave this base behind.

On the daily, you see volatility (BBW) explode as the price moved up and to the right of the screen, then take a break and consolidate since January. We're entering the trade during a relatively quiet period, when the short-term momentum chasers are out but strength is quietly building and individual stocks are getting accumulated.

The final piece of the puzzle is the Relative Strength (RS) indicator. This compares the performance of XBI relative to the S&P 500 ETF (SPY). On the daily chart, you can see that the RS was declining until November 2023 but is now trending higher, meaning XBI is starting to outperform. The weekly shows that there is a lot of room for it to run higher, coming off a long period of underperformance.

A sub-sector that's outperforming the SPX will become a go-to trade for the momentum traders, quants and trend followers once they stop obsessing over the Mag 7 and semiconductors.

The added fundamental story (Ozempic for the growth investors, net-net for the value investors) makes this a sector that will see a lot of crowding if I'm right in my reading.

I've built a watchlist of individual names but for now, buy the ETF.

Good Trading!

Kashyap Sriram

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