Buy LABU: Biotech Sector Benefits From Lower Interest Rates And AI

ktsimage/iStock via Getty Images Introduction In an article published in December 2023, I rated Direxion Daily S&P Biotech Bull 3X Shares ETF (NYSEARCA:LABU) a Buy. That was a good call since LABU went on to gain 65% during the following two and a half months. But, over March and April, LABU sold off hard, declining 52% from top to bottom. The selloff was caused by disappointing inflation data over the first quarter and the subsequent decrease in market expectations of interest rate cuts. The situation has changed recently and the biotech industry entered a favorable period. Therefore, in this article, I reiterate the ‘BUY’ rating of LABU. The chart below shows the evolution of LABU’s total return since my first “Buy” recommendation. StockCharts.com LABU Is a 3X Leveraged Fund LABU is highly leveraged and poses great risks of huge losses in a short time. The chart above shows a 52% loss over a two-month period. Investors should be aware of the risks involved in trading leveraged funds. An in-depth description of the risks of holding LABU is available in this SA article. Investment Thesis LABU has entered a period of favorable economic environment and is expected to make big gains in the second half of the year. There are two main factors supporting this argument: (1) The Fed is expected to start cutting interest rates, and (2) The application of AI will increase the productivity of biotech companies. From a technical point of view, LABU is in a strong uptrend that started after the publication of the June CPI report. The Seeking Alpha Quant currently rates LABU’s momentum as B. Chart Analysis The chart below shows the price action of LABU over the last nine months. It has been in an uptrend, except for a steep decline in March and April. Since July 5, LABU posted an 8-day uninterrupted sequence of positive returns followed by a 3-day pullback. StockCharts.com In the chart above it is apparent that LABU is in an uptrend that started in April. The current price is well above its 50-day moving average. Over the last two months, the 50-day moving average acted as support. Biotechs and Small-Caps Biotech and small-cap stocks are very much affected by the Fed’s interest rate policy. The recent changes in interest expectations have caused a sector rotation from large-cap technology to small-cap defensive sectors. The next chart shows the total returns of LABU (green), TNA (blue), and SPXL (red) over the period from July 3 to July 19. LABU (21.57%) and TNA (22.12%) have big positive returns, while SPXL (-2.06%) declined. stockchart.com It is remarkable how similarly the biotech and the small-caps have responded to changes in interest rate outlook. The following chart shows that biotechs and small-caps may produce exceptionally high returns in relatively short time intervals. stockchart.com Over a 4.5-month period from 9/24/2020 to 2/8/2021, LABU returned 274%, TNA 270%, while SPXL returned 79%. Risks LABU may produce exceptional returns, but that may also come with high risks. The main premise of my rating is the expectation of interest rate cuts starting in September. If that expectation fails to materialize, the biotech sector will, likely, disappoint. Currently, LABU’s price is in a pullback. Is this pullback over, or is it the beginning of a correction? We will find out soon. Finally, LABU is a leveraged fund that may suffer value erosion and should only be used as a tactical, short-term investment vehicle. Here is a detailed message from the SEC on the risks inherent in leveraged ETFs.

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