Beware the Biotech Bubble

Other Last Shoe to Drop

I've been skeptical of late but can't close my nostrils to the truth: The bloom is back on the

Nasdaq's

rose. It's in the air. You could smell it and see it today as the index jumped 2.9% behind traditional tech giants such as

Intel

(INTC) - Get Report

and

Cisco

(CSCO) - Get Report

, as well as re-energized highfliers such as

Juniper

(JNPR) - Get Report

,

Ariba

(ARBA)

,

Emulex

(EMLX)

and

Phone.com

(PHCM)

.

In addition to the tech favorites, the Comp also got a big boost today from biotech and genomic stocks, which rambled higher on positive news from

Genzyme

(GENZ)

,

Affymetrix

(AFFX)

and

IDEC Pharmaceuticals

(IDPH)

. Genzyme climbed 6.6% after receiving a favorable ruling on Fabrazyme, clearing the way for likely

Food and Drug Administration

approval early next year. Affymetrix soared 30.1% after the

U.K. Court of Appeals

reversed a lower court ruling that required the company to pay royalties to a competitor for use of technologies used to determine the activity of genes. IDEC rose 5.2% after announcing its application to market Zevalin as a treatment for non-Hodgkin's lymphoma received "fast track" status with the FDA.

A host of other names in the sector rose in concert, notably

Millennium Pharmaceuticals

(MLNM)

and

OSI Pharmaceuticals

(OSIP)

, each to 52-week highs. The

Amex Biotechnology Index

, or BTK, rose 4.9%.

Which brings us to the crux of tonight's column. When optical-networking stocks crumbled last week, shareholders' wounds hadn't even been sutured when the optimists delivered the morphine. The bloodbath in optical networking stocks was a "good thing," they declared, because the group was the "last bubble" that needed to burst to purge the final excesses.

Anyone who still believes the excesses have been purged after today's ramp, please see me after class.

So about those biotechs, which produced a huge bubble in late 1999 that burst in furious fashion in early March 2000, presaging the overall Comp's decline. Somewhat surreptitiously, the biotech bubble has returned: Since its low on April 14, the BTK has nearly doubled, up 92.5%.

There's no doubting the advances being made in the biotech industry are astounding. But it seems investors flocking indiscriminately into the group learnt nary a lesson from the last attack of bio-bubbleitis.

That, at least, is the belief of Michael Shaoul and Timothy Brackett of

Oscar Gruss & Son

, a nearly 100-year-old investment and merchant banking firm that specializes in health care, communications technology, risk arbitrage and special situations.

In a Nov. 1 report titled "Biotechnology: Last of the Momentums?", Shaoul and Brackett argued that biotech stocks reflect a "wider phenomenon" in the market. Specifically, the "inability to place concrete value on future return of new and little understood technologies."

As a result, such industries are subject to periods of egregious over- and under-valuation (in case you hadn't noticed), they contend. Currently, biotechs are in the former stage.

"What's happening today is just over-optimism," Shaoul said. "It's not a sign of a market really digesting news. I have a problem when everything on my screen in biotech is up 2% to 7%."

Shaoul, Oscar Gruss' chief operating officer, is hardly bearish on biotech and isn't recommending shorting the group because "I can't tell you when it stops" going up, he concedes. But "the whole sector is a little saucy."

The outlook is gaining credence on Wall Street. John Roque, senior analyst at

Arnhold & S. Bleichroeder

(and

RealMoney.com

contributor), issued a report earlier this week in which he compared the biotech index of today to the

Philadelphia Stock Exchange Semiconductor Index

of June 2000, "when the components of the SOX and other semis started to deteriorate but the SOX remained relatively insulated."

For those with short memories (a large group, it seems) that insulation proved thin: From its summer highs on July 14, the SOX eventually fell nearly 45% before bottoming (apparently) on Oct. 27.

Meanwhile, even a generally bullish piece released this week by fundamental analysts Tim Wilson and Akhtar Samad of

Bear Stearns

concedes "that a significant component of today's bull market is an overreaction to prior nondiscriminatory undervaluation."

Again, these are not people who "hate" biotech or want to see you lose money; quite the contrary. They are merely observing the potential danger signs, which seem eerily reminiscent of past periods of excess in the sector. Having been "sucker punched" by bandwidth stocks, Shaoul said he co-penned the report in part to avoid repeating the experience.

Previously, I've argued that the biotech sector can be viewed as a microcosm of broader trends in Nasdaq trading. The message being that if you've got to play, do so intelligently. If you're long a bunch of biotechs, employ stop losses or consider buying puts on the BTK or

Biotech Holders Trust

(BBH) - Get Report

, which is now up 57% from its May 26 low. In short, take protective measures. And, for heaven's sake, stay off or get off margin.

Something to keep in mind as the Comp starts to blossom again.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.