Biotech Is on Fire

 | Jan 21, 2014 | 6:00 PM EST  | Comments
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Stock quotes in this article:

IBB

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XBI

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amgn

Shares biotechnology stocks are on fire almost universally and that is driving up the price of associated exchange-traded funds. The iShares Nasdaq Biotechnology Fund (IBB) is up 13%, and the SPDR S&P Biotech ETF (XBI) is up 23% since the beginning of this year. That trend does not appear to be slowing down, either.

I first wrote about this sector the day after Christmas 2012 in the column, "The Real Tech Boom Is Just Beginning." Since then, XBI has doubled and IBB is up 85%. What's most interesting about this is that there is no overlap between the top-10 holdings of each ETF. The largest holdings of each ETF are distinct. The entire sector is rising simultaneously and appears to be synergistic.

Another telling sign attesting to the strength of the sector is that XBI is concentrated with about 60% of its investments in its top-10 holdings, while IBB is more diversified with less than 20% of its investment capital in the top-10 holdings.

As I had written previously, the sector is in the early part of the takeoff phase of the S-curve that will probably continue for another five to 10 years. Although it is still possible that the stocks of the companies in this sector will suffer from a reversal in the event of a broader market correction, the underlying story -- the advancement of technology -- will remain.

The only company of the top 20 combined holdings of each ETF that is paying a dividend is Amgen (AMGN), which is held by IBB. Almost all of the holdings of IBB are earning money, however, whereas the holdings of XBI are generally smaller and not yet posting positive earnings. As such, neither should be considered an income vehicle. But for speculators looking for growth over the long term and investors with an ability to allocate resources to growth, the probable returns in this sector over the course of the next several years look stellar. The most prudent course of action for anyone wanting to participate in the growth is to take a position now and accept that there may be a cyclical reversal in the immediate trend, because there may not be.

As the sector moves further into its S-curve growth, mergers and acquisitions should commence with the companies in IBB being the acquirers of the companies in XBI. That should be beneficial for both ETFs, although that process may still be a few years off.

For investors looking for growth while remaining interested in when the companies will start to throw off dividend income, IBB is the way to invest now. Dividend income will almost assuredly not be a part of any of the company's prospects, however, as positive earnings will most probably have to be allocated to acquisitions.

Growth in this sector will also be very disruptive to the economy overall, as it will accelerate the rate at which jobs currently performed by people will be converted to being performed by non-humans (an issue I've written about before on Real Money). Although it is recognized by academics and monetary policymakers, it is still too new to be considered in policy decisions.

As empirical evidence of the shift toward returns on capital versus labor mount, it will have a major, and perhaps dominant, impact on monetary and fiscal policy, along with taxing policies at all levels of government and the structure of government itself, both nationally and at the state and municipal level.

I'll discuss what those changes will logically be in future columns, along with their impact on capital markets. For now, investors should be watchful for monetary policy officials and politicians discussing the disruption to employment that will occur as technology advances.

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