There's an eye-popping alternative to overheated tech stocks

Chemistry lab professorNTNU, Faculty of Natural Sciences and Technology/FlickrThere are some eye-popping opportunities in large-cap biotech right now, and they’re coming at the expensive of tech.

In 2017, the best way to beat stock market benchmarks has been to simply buy tech shares. But as that strategy looks increasingly unstable, an intriguing alternative has emerged: large-cap biotech.

The fragility of the tech sector was on full display on Thursday, as the Nasdaq 100 dropped as much as 1.7%, more than double the biggest intraday loss for the broader S&P 500.

In a market largely devoid of price swings, tech has remained a lightning rod for sharp fluctuations. And while the Nasdaq’s 22% year-to-date surge is among the best you’ll find, traders are starting to look elsewhere.

That’s been the experience of Credit Suisse chief US equity strategist Lori Calvasina, who says investors have told her they see biotech as an “interesting alternative” to tech. And while she personally isn’t yet racing to the rooftops to make the case for biotech, she sees a handful of very compelling reasons why it’s a good bet.

Screen Shot 2017 07 27 at 4.09.57 PMCredit SuisseInvestors are the least bullish in five years on large-cap biotech.

The first stems from one of the most popular arguments against tech — that everyone has been chasing outperformance by piling in, making it one of the market’s most crowded trades. Biotech doesn’t have that problem. In fact, Credit Suisse finds that sentiment on large-cap drug developers is the lowest in roughly five years. In other words: there’s opportunity there.

Further, while tech accounts for eight of the 10 most popular overweight positions for large-cap growth funds, biotech has just one representative.

Screen Shot 2017 07 27 at 4.20.51 PMCredit SuisseLarge-cap biotech is trading close to the cheapest since 1993, relative to the benchmark S&P 500.

Another argument in favour of large-cap biotech is that it’s currently inexpensive relative to the broader market. The group’s forward price-earnings ratio is close to the lowest since 2003, relative to the same measure for the Russell 1000, Credit Suisse data show.

Biotech found itself in a unique position heading into the presidential election last year. It plunged 13% in the six weeks heading into November 8 on speculation that, if Hillary Clinton won, she would make good on her promises to cut drug prices. While the group surged after Trump’s surprise victory, it’s been chasing the stock market’s grind higher ever since.

Calvasina stresses that this is not the case for the broader healthcare sector, which includes hospitals, managed care providers and device-makers, among others. It’s simply not attractively price like its biotech sub-sector.

But overall, the healthcare sector has enjoyed inflows into exchange-traded funds. The group has actually been the beneficiary of outflows from tech funds, Credit Suisse finds.

Screen Shot 2017 07 27 at 4.29.35 PMCredit SuisseFlows into healthcare funds have increased as outflows from tech ETFs have mounted.

For example, an ETF tracking healthcare companies in the S&P 500 has absorbed a net $US848 million in fresh capital since the start of June, while its comparable tech fund saw $US419 million of outflows, according to data compiled by Bloomberg.

Amid all of these positive drivers, Calvasina is far from blindly confident about large-cap biotech. She recognises a few potential headwinds for the sector.

That most notably includes the manner in which biotech stocks have historically gone in the opposite direction of interest rates. With the Federal Reserve in the middle of hiking rates and making plans to unwind its massive balance sheet, this is a legitimate concern.

Additionally, recent earnings momentum in the past has been “lacklustre” for large-cap biotech, both compared to the group’s history and versus tech and healthcare, Calvasina says.

In the end, there’s no telling if biotech will live up to the potential it appears to have, especially with these threats looming. But you could certainly do a lot worse if you’re looking to escape a tech sector that appears to be reaching critical mass.

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