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Why October could be bad for biotech

Just a few days ago, they were one of the hottest sectors this year. Now biotechs are getting dumped by investors just like nearly everything else. But are strong gains ahead for the group?

Since hitting all-time highs last week, the ETF that tracks the biotech sector (trading under the symbol IBB) has dropped 3 percent. Some of those losses happened Wednesday as investors bailed out on stocks across the board.

Yet 2014 remains a pretty good year for the sector. Despite the recent pullback, the IBB is still up 19 percent this year. That sort of run may continue, according to one analyst who covers the industry.

"Fundamentally, we're real bullish on the sector," said Eric Schmidt, analyst at Cowen & Co. He cites a new product cycle and pricing power as two catalysts for the group.

"We've got companies that, independent of the economy, are growing 20 percent-plus per year," Schmidt said. "So it's no surprise to us that the IBB is up about 20 percent year-to-date. I think you can expect the same in the next 12 months."

The long-term technicals may agree with Schmidt but the short-term charts on the IBB are not as promising, according to Jonathan Krinsky, chief market technician at MKM Partners.

Krinsky's charts show the IBB moving along in a rising wedge pattern. "If you're a long-term investor, you can ride this channel," he said. "It's a bit steep for our liking but until it breaks that $240 level, you're probably OK."

But it's the shorter-term daily chart of the ETF that has Krinsky concerned. The IBB has remained above its 200-day moving average for nearly two years. The problem he sees is that the recent highs may have actually been a false breakout above resistance set at its February highs.

"That creates this false breakout," he said. "They say that from false breakouts come fast moves in the opposite direction. I think that's what we're getting. We'd look for a pullback back down to the 200-day."

The 200-day moving average in the IBB is $248. The ETF closed Wednesday at $269.43.

Another factor for the IBB is the calendar, but that could break either way. The technicals say this month should be negative while Schmidt thinks we could see positive news.

"Historically, October is the worst month for IBB over the last 10 years, averaging about 1.7 percent declines," Krisky said, adding that he would be a seller of the ETF. "So if you're looking to get in, we'd probably say at least wait until a bit more selling goes through this month."

However, Schmidt believes the fundamentals may buck that trend. "We do have Q3 earnings coming up for this sector," he said. "Last quarter, six out of six of the largest companies beat and raised [forward estimates]. We kind of expect more of the same as we get into that earnings environment in the third and fourth week of the month."

To see the full discussion on biotechs, with Schmidt on the fundamentals and Krisky on the technicals, watch the above video.

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