Whenever I start talking about “mean reversion,” I prepare for people’s eyes to roll back into their heads. It’s complex as far as topics go, I realize… but it’s also one of the deadliest forces in the market, and it can wipe out as much as 90% of yours gains if you’re not careful.
You see, there are two types of mean reversions.
The first is what I call your “everyday variety” of mean reversion. This is when market prices, after rising mildly for a day or two, fall mildly for a day or two. It’s so subtle that you hardly notice it happen. It’s also routine and completely harmless.
The other type of mean reversion is not-so harmless. In fact, it’s the most devastating, wealth-destroying kind.
I call this the “boom-to-bust” variety of mean reversion. And avoiding its wrath is absolutely critical to capital preservation and the long-term success of your investment portfolio.
The bad news, today, is that I’m beginning to see the early signs of a boom-to-bust style of mean reversion in an industry that I’ve long favored.
And if the bust side of this industry’s cycle plays out… I’ve identified two ETFs that could lose between 45% and 70% in as little as 12 to 18 months.
These industry-specific ETFs are already down 30% since July, meaning they’re officially in a bear market. But as I’ll show you, history suggests they still have a lot more to lose.
I’m going to run through a couple examples so you can see what I mean.
First, the Miners
The metals mining industry was the first to go through a boom-to-bust mean reversion cycle since the bull market began in March 2009.
At one point, in April 2011, the SPDR S&P Metals & Mining ETF (NYSE: XME) had gained an astonishing 230% off the March 2009 lows, just two years prior. And the price of copper (JJC) was up more than 160%.
Meanwhile, the SPDR S&P 500 ETF (NYSE: SPY) had gained only 80% over the same time.
So copper prices had doubled the gain produced by stocks… and the shares of metal miners had nearly tripled them. Clearly, the industry was booming.
But not for much longer, as you’ll see in this chart:
A boom-to-bust style of mean reversion struck the metals markets in 2011. Four years later, and the industry still hasn’t recovered. Miners’ stocks (XME) are now trading 28% below their March 2009 prices… losing the entirety of their 230% gain, and more!
Of course, plenty of investors made money on mining stocks on the way up. That is… if they got out in time. The price weakness turnrned out not to be temporary. And investors who thought there was an opportunity to buy the dip were truly sorry.
Next, the Drillers
Shortly after the mining industry began its dreadful decline, the oil and gas industry showed investors promise of a new, up-and-coming boom.
For the entire bull market that began in March 2009, the SPDR S&P Oil & Gas Exploration ETF (NYSE: XOP) and the SPDR S&P Oil & Gas Equipment ETF (NYSE: XES) outperformed the S&P 500.
By June of last year, the stocks of oil and gas producers were beating the broad market by a full 70 percentage points.
Just like the mining industry, the oil and gas industry appeared to be booming. And just as miners met a dreadful fate, oil and gas stocks too got hit with the bust-side of a nasty boom-to-bust mean reversion cycle, as this chart shows:
Again, there was good money to be made on the boom-side of this cycle. That is, for investors who acknowledged the changing of tides quickly enough…
Because in just 15 months, both oil & gas producers (XOP) and equipment providers (XES) gave back a full 90% of the gains they had accrued between March 2009 and June 2014.
This industry-wide decline, too, appeared to be temporary at first. But it wasn’t… and so any investor who ignored the newly-emerging downtrend – either waiting for a recovery or, worse, buying the dips – fared quite poorly.
Now, the Pill Providers
The health care industry is looking like it might be the next major U.S. industry to meet the vicious fate of the bust-side of mean reversion.
This is troubling for a number of reasons, not least of them being that I’ve long viewed the health care industry as one of the most robust and promising sectors of the U.S. economy.
My bullishness on the sector has been based on a number of factors. Fundamentally, the baby boomer generation has been, and will continue to be, a driving force of demand for health care services, equipment and pharmaceuticals.
And technically, health care stocks have shown in recent years the ability to lose less in down markets and gain more in up markets – a wonderful, have-your-cake-and-eat-it-too sector that any investor would be happy to own.
But health care stocks have suffered badly through the broad market sell-off that began in late August. Since August 1, the sector has lost nearly 12%, while the S&P 500 is down just 5%.
And the troubling news is… the health care industry might just get worse before it gets better.
This is particularly so for the most speculative and volatile subsets of the health care industry, namely biotech and pharmaceuticals.
And it shouldn’t be too hard to see why. These high-flying subsectors have clearly already enjoyed the boom-side of the boom-to-bust cycle… just as miners had by late 2010, and oil companies by early 2014.
Take a look at this chart, which shows the SPDR S&P Biotech ETF (NYSE: XBI) and the SPDR S&P Pharmaceuticals ETF (NYSE: XPH), relative to the S&P 500:
I trust you can see the similarities between biotech/pharmaceuticals, today, and the once-boomed-now-bust mining and oil industries, as they looked at their respective peaks.
Simply put: biotech has boomed too long, too far… and it’s due for the bust-side of its boom-to-bust mean reversion cycle.
Cycle 9 Alert readers have an open trade betting on one pharmaceutical company’s downfall. It’s not too late to get in on that trade.
To good profits,
Chief Investment Strategist, Dent Research