SPDR S&P Biotech ETF (XBI): Market Runs From Risk In Uncertainty

Introduction

I am bearish on SPDR S&P Biotech ETF (XBI). Investors will rotate money away from riskier investment sectors such as Biotech and move into safer sectors as the Fed raises rates and high inflation persists in the economy.

For a bit of background, XBI is a fund created to track the S&P Biotechnology sector. Unlike many ETFs such as the S&P 500 (VOO), XBI is an equally weighted fund. This means that the fund buys proportional amounts of each security regardless of market cap or share price rather than buying amounts proportional to each securities market caps like most funds do. If investors are looking for a market-cap-weighted fund for the biotech sector, they should look at iShares Biotechnology ETF (IBB). Additionally, these two funds focus on different areas of the sector. XBI focuses more on small-cap companies, whereas IBB focuses more on the big cap name brand biotech and pharmaceutical companies (think big pharma).

Top Holdings

Currently, the top holdings are:

The top holdings will change as time progresses and will be reweighted equally when the fund reweights.

Market Trends

As is evident from the one-year stock chart, XBI has fallen precipitously over the past year. The stock has fallen 37.7% over the past year and sits just above its 52 week low. Whenever a stock falls this much, it is easy to think that one should buy XBI, and it won’t lose any more value. I, however, believe that this fall is just the beginning.

Recently, the Fed said they would raise rates faster than many people expected, even going as far as to say they might raise them three times in 2022. When rates are increased, this typically leads to the lowering of the price of securities. The price lowering is especially true in the biotech sector because when investors can get a better return on a bond, they are less likely to look take on the higher risk found in securities for a good return rate. This trend also occurs within the securities market, investors move from riskier securities to safer securities, and small-cap biotech stocks are some of the riskiest securities around.

Another economic factor to consider is inflation. Historically the market has performed poorly when inflation quickly spikes. Additionally, inflation causes investors to move money out of growth stocks into value stocks. The reason is that the future earnings of the growth stock are not worth as much because inflation will eat into them. What sector of the stock market is primarily based on companies that do not have any current earnings and are whose companies are mainly valued on potential future earnings? The answer is biotech companies and, more specifically, small-cap biotech companies just like XBI tracks.

If both of these negative market factors for XBI continue to happen, I think it will be hard for XBI to perform in the green no matter how well some underlying assets may end up performing. It is much harder for a whole sector to break against economic trends than for a single security.

Risks

If any of the general market trends I have mentioned change, this will change the stock’s outlook. For example, if inflation gets to a more reasonable number and the Fed does not raise rates, the stock will perform much better than expected. Outside of general market trends, which is what XBI shows best, most of the companies in this fund do not have any profits and are in the developmental stage of their drug candidates. Because of this, the fund is at risk of going down upon drug failures and up upon drug approvals. If many companies in the fund got drug approvals and good results in drug trials, the fund would perform better than I anticipated.

Conclusion

While I like XBI as an investment, especially as an investment into smaller biotech companies, I do not think it will perform very well coming up. Many of the companies in the fund are very risky plays based on drug approvals. One, investors are going to move to safer investments with the Fed raising rates, and two, investors are not going to value future cash flow from these drug approvals as highly with the current high rates of inflation.