Last week, Austin wrote about the incredible run biotech has been on and how it has propelled Sound Mind Investing's Sector Rotation strategy to fantastic profits over the past two years. In that post, he linked to analysis offering a number of solid explanations as to why biotech could well have further gains in store. I found the P/E argument (that biotech P/E ratios haven't risen much above their long-term norms) particularly compelling. But as you know, there are always two sides to every story.
(And this time, the other side comes complete with a flashy picture, which I often find irresistible.) A chart from Bespoke Investment Group (via this Marketwatch article), might initially seem to indicate that the Biotech run has further to go, as its total gain since biotech's run began in March of 2009 is substantially less than the prior two big equity "bubbles" of Nasdaq Internet stocks in the late 1990s and Homebuilder stocks in the early 2000s.
But what the chart actually intends to show is that in terms of length, this biotech "bubble" (if it can be called that) is getting very close to the point at which both of those prior bubbles peaked. And then cratered.
“Bubbles certainly come in all shapes and sizes, and while the biotech group’s rally since March 2009 has been much less than the rally we saw during the dot-com and housing bubbles, the length of time the current rally has lasted for biotech is getting close to the time the prior two bubbles lasted,” the note says. “If biotech’s rally lasted as long as the dot-com bubble lasted, it would come to an end in late June. If it lasted as long as the housing bubble, it would come to an end in late July.”
1. Both of those prior bubbles followed the typical pattern of going parabolic at the end, with enormous gains at the very end of the run. We may be in the midst of a similar run in biotech, but it's fair to say that if this is a similar bubble, those type of crazy gains are likely to last right to the very end.
2. Everything Austin wrote last week about rebalancing and potentially locking in gains is more than just theoretical. When the tech bubble burst, our back-tested SR data would have had us sell pretty quickly — just two months after the peak. But not before suffering a -27.18% loss in just a single month (April 2000). The way investing math works, you don't get to subtract the 27% from the 148% gains we have in biotech so far. That's 27% of the total value, meaning a total gain of 148% would become a total gain of "just" 81% in a single month if that same type of decline were to occur.
(The easiest way to "see" this for the non-math-equation-inclined is to consider an initial $100 investment. It grows 148% to a total of $248. A 27% loss from that point would reduce the total to $181, which is an 81% gain from the original $100 investment.)
Of course, there's certainly no guarantee that type of scenario is going to occur. We just want everyone to understand the possibility, especially given that this Sound Mind Investing strategy has been a one-way ticket to riches for over two years. Some newer readers have never seen SR decline and we want them to understand the risks and why we recommend limiting SR to no more than 20% of your stock allocation.
Personally, like Austin, none of this changes anything in terms of how I am approaching my Sector Rotation holdings. I understand the risks and am comfortable continuing to hold on until the strategy says it's time to sell. As long as you understand the risks too, that's a perfectly reasonable conclusion. But so is pocketing some gains and dialing down your portfolio's risk level if you're so inclined.
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