It was one of the craziest market reactions you'll ever see...
Last month, Moderna (MRNA) and Merck (MRK) announced promising late-stage trial results for a personalized cancer vaccine. If those results hold up in further testing, the vaccine could be a game changer for cancer treatment.
The wild biotech sector reacted accordingly...
Shares of Merck – which is a much larger company – went up more than 12% on the news. Meanwhile, Moderna soared a staggering 177%... in a single day.
That's the kind of moonshot potential that's possible in the boom-and-bust biotech sector. And it has already been a strong year in biotech. The sector was up more than 20% on the year before Moderna and Merck's report.
Now, this part of the market appears to be overheating. But in this case, selling would be the wrong choice. Instead, we could see an additional 27% rally over the next year.
Let me explain…
Don't Sell Biotech's Overbought Rally
Sentiment doesn't affect every part of the market the same way. That's especially true for boom-and-bust sectors like biotech.
The sector was flat for the year as of early June. Since then, though, it has rallied by as much as 30%. And that scorching rally sent biotech to what would normally be a concerning level based on the relative strength index ("RSI").
The RSI tells us if an investment has gone too far, too fast in either direction. An RSI below 30 tells us investors sold too quickly... and a snapback rally is possible. And an RSI above 70 tells us to expect a cooldown after a hot buying spree.
In this case, the RSI for the Nasdaq Biotechnology Index ("NBI") recently jumped above 80. Take a look...
Typically, this would be a bad sign. It would tell us that buyers could soon dry up... and prices are due to fall.
But biotech isn't a typical sector. When it booms, it really booms. And history shows that this kind of RSI extreme isn't a reason to sell. It's a reason to buy.
We've seen this kind of setup in the NBI 14 other times since 1993. And those were darn good times to put money to work. Take a look...
Biotech stocks tend to boom and bust, but they're still solid long-term investments. The sector has grown 11.5% per year over more than three decades.
The surprising thing is, you can do much better by buying into the sector when it seems to be overheating. Those setups led to gains of 4.1% in three months, 10.9% in six months, and 27.1% over a year.
Those are big returns in their own right... and massive outperformance compared with a buy-and-hold strategy.
Not only that, but these setups have a strong win rate, too. The sector was higher a year later 86% of the time.
You can easily capitalize on this trend through the iShares Biotechnology Fund (IBB). This simple fund gives you broad exposure to the sector. And for biotech stocks, even a diversified bet can lead to big gains during a major boom.
So while it may seem like this sector has rallied too far, too fast, history shows a slowdown isn't around the corner for this group. Instead, biotech stocks could rise another 27% over the next year.
Make sure you're positioned to take advantage of this sentiment exception.
Good investing,
Brett Eversole
Further Reading
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