The market just wrapped up its worst performance week since September 2011 as concerns around China overwhelmed any bullish indicators.
High-beta sectors like small caps and the entire biotech sector have been hit particularly hard, with both areas in official correction territory.
I have been predicting that the biotech sector looked like it was in bubble territory, but investors should selectively use the recent downtown to do some strategic and incremental buying.
"I have seen many storms in my life. Most storms have caught me by surprise, so I had to learn very quickly to look further and understand that I am not capable of controlling the weather, to exercise the art of patience and to respect the fury of nature." - Paulo Coelho
Unfortunately, my prediction that the market was overdue for a 10% correction in early July has arrived faster and in a more brutal way than I imagined when I penned that article six weeks ago. As expected, the trigger for the worst week in the market since September 2011 was China.
Investors should not be shocked by the deep sell-off, other than perhaps the speed with it has hit equities. Year-over-year revenue and earnings growth has been nonexistent throughout the first half of 2015, as a strong dollar, tepid global demand and a complete collapse in the commodity and energy complexes have taken their toll.
Worldwide growth is on its worst yearly trajectory since the financial crisis year of 2009. Emerging markets are sporting their lowest valuations since April 2001, as the collapse in most commodity prices has hit currencies and economies in commodity exporting countries like Brazil, Canada, and Russia quite brutally.
The United States continues to trudge along at two percent growth, as the weakest post-war recovery on record continues unabated. Japan contracted in the second quarter, and Europe is barely above stall speed. In addition, at some point, some sort of significant correction was almost destined as soon as the Federal Reserve finally ended a half dozen years of quantitative easing in October of last year.
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As can be seen from the chart above, the market has basically gone nowhere since the Fed quit their extraordinary liquidity support ten months ago, and that was before last week. The quintupling of the Federal Reserve's balance sheet since the financial crisis and keeping interest rates at basically zero has done a fine job of pumping up just about every asset value, including stocks, real estate and even art. Unfortunately, combined with poor fiscal policies and a regulatory onslaught over the past six years, the Federal Reserve's efforts have failed to ignite much economic growth and, as some have opined, has also been a key factor behind the growing wealth inequality in the nation.
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Not surprisingly, the high-beta stocks and sectors of the market have been hit particularly hard during the market's recent downtown. Small caps are down some 11% from recent highs, the biotech sector has given up approximately 15% of its gains over the past year and even high-flying momentum stocks like Netflix (NASDAQ:NFLX) are finally giving up the ghost after spectacular runs. The biotech sector has looked overdue for a significant pullback for some time.
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As my regular readers on Seeking Alpha and Real Money Pro know, I have been slowly taking up my cash levels for many months within my own portfolio. Those levels stood just north of 30% before this week's big decline. I did put some money to work late on Friday, and I am down to a 25% cash allocation now, after doing some selective buying on the 21st.
In today's article, I want to discuss how I am approaching the volatile but lucrative biotech sector, which is giving investors some much lower entry points after nary a buyable dip since the last big sell-off in the sector back in March 2014. Today, I will talk about what I am doing in the large cap part of the space, as I believe that is where investors should start to nibble. Later this week, I will articulate a couple of more speculative small cap concerns I am looking at increasing my allocation to, as the recent decline has made them more attractive.
I don't feel anyone has a good handle on how long or how brutal this downturn could turn out to be at the moment. Friday did feel like it had an air of capitulation in late trading, and I would not be surprised to see some sort of bounce early next week. Of course, if the Chinese market takes its next leg down on Sunday night, all bets are off.
In the biotech space, I would advise focusing primarily on establishing or adding to stakes in some of the large cap growth names in the sector for the moment. These are growth at a reasonable price (aka, G.A.R.P.) selections that have consistent revenue and earnings growth, solid pipelines and balance sheets, sell at reasonable, if not attractive, valuations and pay a nice dividend to boot.
These large cap names held up much better during the last bad pullback in the sector during March and April 2014. They were also were the first part of the sector to bounce back after the sell-off ebbed. I always advise that investors should have 50-75% of their overall biotech allocation in this part of the sector, depending on their risk profile and preferences. I would be leaning to a heavier allocation within that range at the moment, until sentiment improves on the sector.
This will help take a great deal of volatility out of an investor's biotech portfolio. Four times the small cap biotech sector has suffered 20% or worse declines since the end of the financial crisis in 2009. Their larger cap brethren have not suffered one such sell-off over the same time frame.
I added a few shares to my core stakes in AbbVie (NYSE:ABBV) and Amgen (NASDAQ:AMGN) late on Friday. AbbVie is offering a nice entry point after pulling back some 10% from recent highs. The company is seeing revenue growth in the low teens, with earnings moving up faster than that. In addition, the stock pays a three percent dividend yield after its recent decline and sells at just 13 times next year's current earnings consensus - a significant discount to the overall market.
Amgen is offering an even more attractive entry point after declining some 15% from recent highs, despite easily beating both the top and bottom line expectations when it reported quarterly numbers on July 30th. Earnings are advancing at a 10-15% annual clip on back of mid-single digit revenue increases. The stock is not expensive at 14.5 times next year's consensus earnings forecast, and also pays an almost two percent yield.
Neither of these large cap growth stocks is going to generate "home runs" like their small cap brethren are capable of doing when drug development leads to a successful product approval. However, they are good "bread and butter" picks that should be the foundation of any long-term optimized biotech portfolio. Later in the week, we will discuss some promising but speculative small cap concerns that can add some spice within that well-diversified portfolio.