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The One Stocks Indicator to Watch as More Bubbles Burst

Companies / BioTech Sep 28, 2015 - 08:20 AM GMT

By: ...


Michael E. Lewitt writes: One by one, the bubbles are bursting…

First it was the commodities bubble that blew up in mid-2014, which caused the collapse of energy and commodity stocks -they are now down between 40-80%.

It also caused the end of the corporate credit bubble in high yield bonds and bank loans over the second half of 2014 and into this year.

Then the Chinese stock market, which had gone parabolic early this year, collapsed, sending global markets into a tailspin this summer.

Last week we saw the bursting of another bubble – the biotech bubble. Starting April 7, 2014, the iShares Nasdaq Biotechnology ETF (Nasdaq: IBB) almost doubled, rising from $215.46 per share to a high of $397.59 per share on July 13, 2015.

Needless to say, it was cheered on by breathless Wall Street analysts who were paraded on CNBC to explain why investors should run out and mortgage their houses to buy even more of these overvalued stocks. This was a replay of the Internet Bubble. It was an invitation to lose lots of money.

But a funny thing happened on the way to the insane asylum – reality intervened. And since July 14, IBB has traded back down to $310.20 per share – a loss of 22%. Last week alone, it dropped 13%, including a 5.1% collapse on Friday. Financial media are blaming Hillary Clinton's complaints about high drug prices for the drop, but that is just an excuse. Investors are waking up to the fact that biotech stock prices had no relationship to reality.

For the Decline in Biotech, Thank the Usual Suspects

I told readers of my newsletter to short IBB at the start of 2015 when it was trading at around $300 per share. And as it continued to move higher, I maintained my view that it would collapse under the weight of the delusions pushing it higher.

You see, the biotech bubble had very little to do with biotech. But it had everything to do with the confederacy of dunces known as the Federal Reserve. Biotech stocks were a beneficiary of the epic amounts of liquidity created by our central bankers in their desperate and misguided attempts to sustain the economy.

Like Internet stocks in the 1990s, which couldn't be valued on traditional metrics, biotech stocks were the perfect foil. They are the stuff of hopes and dreams. A successful drug can be worth billions. But the odds of success are very low – like one in a thousand. Las Vegas offers better odds (and better attractions).

So Wall Street geared up its PR machine and started pumping out research to sell investors the fantasy of saving mankind through new drug discoveries. It is a wonderful goal – but 99.9% of the time it is a pipedream. Biotech is venture capital by another name. Buying biotech stocks is also gambling by another name when stock prices reach become as overvalued as they have in this market cycle.

Today's biotech stocks should carry the following warning on it for individual investors – "Don't try this at home!" Or perhaps a better warning label would be "Losses are closer than they appear!" Anything is possible, but the rout in these stocks isn't over.

The True Indicator of This Hidden Bear

While biotech was just the latest sector to collapse in what has become a stealth bear market (many stocks are down far more than the 10% that would mark a correction), investors remained obsessed with the Federal Reserve. Janet Yellen attempted to walk back the Fed's confusing remarks of a week ago when she gave a speech on Thursday night (and almost fainted from the strain) and said that she believed there would be a rate hike by the end of the year.

Wow! The Fed is going to raise rates for the first time in nine years by all of 25 basis points in December – if the economic data justifies such a move….That's like saying Donald Trump is going to win the Republican nomination – if he wins enough delegates.

In other words, this is a completely meaningless statement. Moreover, there is little chance that the economic data that the Fed is worried about (i.e. China) is going to improve much at all. So while markets celebrated her remarks with a tepid rally on Friday, the truth is that they really don't know what to think. Remember, it was only a couple of months ago that markets were selling off at the mere hint of a rate hike. This is not a confederacy of dunces – it is a confederacy of idiots.

As a result of all of this confusion, markets didn't do much last week outside the sectors that continued their collapse, including not only biotechs but anything commodities-related. The Dow Jones Industrial Average lost 0.4% or 70 points to close at 16,314.67 while the S&P 500 fell 1.4% or 27 points to end the week at 1931.34. The Nasdaq Composite Index fared much worse on the back of the biotech collapse, losing 3% to close at 4686.50.

Investors should keep their eyes on the stock of Glencore Plc (LON: GLEN.L), the Swiss commodities trading powerhouse that has dropped from a 52-week high of £345.70 to £97.22 as a result of the rout in commodities that began in 2014. Glencore is cutting debt and trying to survive the worst crisis in its brief history as a public company. It is an excellent barometer of the carnage in the commodities space which is nowhere near over.


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