When Biotech Strength Becomes an S&P Buy Signal

The biotech sector has generated some keen interest lately, driven in no small part by the recent FDA approval of the first CAR T-cell therapy for cancer treatment. This development has been the focus of an L.A. Times front-page story, as well as the current "Closing in on cancer" Economist cover.

Against this backdrop, the iShares Nasdaq Biotechnology ETF (IBB) wrapped up the month of August by breaking above its July highs around $330 -- and in fact, during the 10-day stretch concluding Sept. 1, the fund outperformed the broad S&P 500 Index (SPX) by a solid 8%. To determine whether this biotech outperformance might have any greater implications for the market, Schaeffer's Quantitative Analyst Chris Prybal looked back at the returns following previous occasions where IBB/SPX relative strength has been at 8% or higher over a 10-day period.

Surprisingly, IBB relative strength has historically been more of a precursor for continued S&P strength. Since 2000, there have been 22 of these IBB outperformance signals -- and the S&P has consistently outperformed its average "anytime" returns following each, looking at time frames ranging from five days to six months. Plus, the percentage of positive returns also outpaces the norm over every time frame.

For example, the S&P's average five-day return since 2000 is 0.1%, with 55% of those returns positive. Following an IBB outperformance signal, the S&P racks up an average five-day return of 1%, with 68% positive. Over 21 days, the S&P averages a 0.4% return with 61% positive; following a signal, the index is up 2.4% on average, with 71% positive.

This S&P strength is no fleeting phenomenon, either, as the outsized gains and overwhelmingly positive returns continue to dwarf the norm over two-month, three-month, and six-month time frames. In fact, 126 days after an IBB outperformance signal, the S&P is up 3.3%, on average, with 75% of those returns positive. That compares pretty favorably to an average S&P 126-day return of 2.2% and 66% positive.

As for IBB itself, the fund also tends to exceed its "anytime" returns following these signals, albeit for shorter bursts of time than the S&P. IBB's five-day average returns post-signal are right in line with the usual, but its 21-day post-signal average return of 2.5% more than doubles the anytime result of 0.9%. After the two-month marker, though, IBB's momentum seems to taper off, with the average three-month and six-month returns after a signal falling short of their "anytime" counterparts. (Of course, if IBB's post-signal strength is quicker to wane than the S&P's, it's at least partially due to the fact that a non-trivial degree of IBB outperformance is a prerequisite for triggering these signals.)

So far, after this latest signal, the Sept. 1 finish for IBB at $335.84 has been the closing top, with the shares entering a period of apparent consolidation since. By contrast, the S&P has gained about 1% since its Sept. 1 close, and broke out above its early August high near 2,490 in the process (an achievement capped by Friday's photo finish north of 2,500). Notably, since 2016, the IBB post-performance stats have been fairly lackluster compared to the SPX's consistent outperformance -- and this seems to be occurring once again.