Market Anthropology: A Return to Normal – or Fear

Monday, June 9, 2014

A Return to Normal – or Fear

Since breaking down sharply at the end of Q1, we have viewed and contrasted the higher beta biotechnology sector as prospectively pivoting lower from a cycle high of the secular variety. Back at the end of April we had introduced the concept below which depicts overlapping asset cycles that have boomed and bust with strong duration, performance and seasonal tendencies (see Here).

If past is appropriately prologue here, we anticipate that similar to the historic tops witnessed in the Nikkei, Nasdaq and silver – the current move in biotech is working towards completing its retracement obligations – and should resolve lower through the balance of the year. 

Expressed along a quarterly timeframe, the 20 year performance run in biotech measures commensurate with the performance of the tech bubble that exhausted in 2000. Although the retracement rally that began in April has extended the parabolic structure for the index, we expect the balance of the quarter through June to likely erode into the current ~ 3.75% gain for the quarter.

With the equity markets voracious appetite for risk at fresh 52 week highs, beta has been strongly chased and rewarded in the markets. Resultantly, the formerly downtrodden biotech sector has worked its way back to a major retracement level – one that we suspect will cap the rally that began in April. 

Contrasting the proportion of the pattern with the secular high in the Nasdaq – circa 2000, the 61.8% retracement level also served as the top of its retracement range as well.
This was also the case for silver in 2011. 
In 1990, the Nikkei pivoted down in June from its 50% retracement level. The chart data that we have for the Nikkei from 1990 does not provide intraday ranges. We however used the intraday highs and lows to calculate the retracement levels for the index. 
If biotech continues to find traction and trend higher above its 61.8% retracement level, it would be a good comparative benchmark that the damage witnessed to higher beta in early spring was not a harbinger to the broader market and would greatly strengthen the underlying character in the equity indexes. For us, the retracement level delineates either a “return to normal” for the long-standing uptrend in biotech or the topside of a bull trap. The three historic boom and bust cycles described before all share similar reflexive structures that tangibly represent the various market psychologies that occur throughout the cycle – and when an asset fails to “return to normal”. With fear in short supply these days in the equity markets, the long-term performance profile and current retracement pattern in biotech lends strong consideration that the next phase will bring just that.