2009: Positive Outlook for Biotech

|
 |  Includes: AMGN, ARQL, CEPH, ENDP, IDEV, IMCL, LLY, MEMY, MITI, MRK, NPSP, PFE, RHHBY, SHPG, SQNM, VRTX, WYE
by: Michael Becker

After a brief bout of euphoria during the early portion of the decade, the biotechnology industry, as measured by the Amex Biotech Index (BTK), was shunned by investors for the better part of the 1990s.

The BTK, which was established with a benchmark value of 200 on October 18, 1991, declined by 50% to nearly 100 seven years later (around mid-1998) despite improving industry fundamentals, including record levels of late-stage clinical trials, new product approvals, profitable biotechnology companies, and industry merger and acquisition activity. With this in mind, and being somewhat of a contrarian, it was July 1998 that I first started publishing an investment newsletter focusing on biotechnology.

The BTK quickly doubled from its low and reclaimed the 200 level towards the end of 1998. Over a two-year period, the BTK rose from approximately 100 to 800 – from September 1998 to September 2000. In other words, $10,000 invested in the BTK stock index would have turned into $80,000 during this two year period.

But similar to the experience of the 1990s, exuberance turned to despair in the early portion of the new millennium. Once again, it took the BTK seven years to rise above the high of 800 achieved during the year 2000.

By mid-2008, the BTK nearly reached 900 and was outperforming the broader market. Analogous to 1998-2000, it looked like another multi-year biotechnology bull market was beginning – that is until the equity market meltdown that occurred in the second half of the year.

Indeed, 2008 is a year that many investors would like to forget. The Dow Jones Industrial average recorded its worst annual performance since 1931 and the NASDAQ Composite had its worst year since inception in 1971. On the heels of such a miserable year, it may seem counter intuitive to provide a positive outlook for the biotechnology industry in 2009, but there are both fundamental and technical attributes worth considering.

Defensive Sector

The biotechnology sector is often portrayed as defensive given that disease is relentless in both good economic times and bad. Despite medical advances, there remains a need for quality, innovative products to diagnose and treat a broad variety of diseases such as cancer, central nervous system disorders, cardiovascular diseases, diabetes and infectious diseases. This defensive characteristic appears to have held true in 2008 given the 13% decline in the NASDAQ Biotech Index compared to declines ranging from 30 to 40% for the major market indices, such as the Dow Jones Industrials, S&P 500, and NASDAQ Composite. With all of the uncertainties going into 2009, defensive industries like biotechnology may remain in vogue.

More Resources for FDA

Beyond its defensive attribute, new drug approvals by the FDA during 2008 were the highest in three years. Of course, cynics will rightfully call attention to the quarter-century low number of approvals in 2007, that the FDA failed to decide whether to clear many products within the timetable established by Congress during 2008, and that 2008’s performance still pales in comparison to the high of 37 new approvals in 1999. But viewing this in the context of internal resource constraints that have plagued the agency may provide optimism going into 2009, as legislation passed last year gives the FDA more money and resources in 2009.

The Bullish Percent

From a technical perspective, one market indicator turned bullish for biotechnology industry going into the New Year. This indicator, called the Bullish Percent, is based on the percentage of stocks in the broader NASDAQ Biotech Index that are currently trading above their 200-day moving average. A stock that is trading above its 200-day moving average is viewed bullish by technical analysts, while one trading below its 200-day moving average is viewed bearish. Accordingly, if 34 out of the 136 companies in the NASDAQ Biotech Index were currently trading above their 200-day moving averages – the Bullish Percent for the group would be 25%.

In general, Bullish Percent levels above 70% are considered overbought, whereas levels below 30% are considered oversold. However, just because a stock or sector is oversold doesn’t mean it cannot become even more oversold, so the Bullish Percent technical indicator doesn’t turn bullish until the level falls below 30% and then subsequently reverses up by at least 6%. Conversely, the Bullish Percent indicator turns bearish when it goes above 70% and then reverses down by at least 6%.

After the Bullish Percent hit a low of 5% on December 1, 2008, when a mere 7 companies were trading above their 200-day moving average, the indicator has been steadily rising and exceeded the 11% reversal level (calculated by taking the 5% low plus the requisite 6% reversal) required to turn bullish. In fact, the Bullish Percent reading was 21% as of December 31, 2008. Amgen (NASDAQ:AMGN), ArQule (NASDAQ:ARQL), Cubist (CBST), Cephalon (NASDAQ:CEPH), Micromet (NASDAQ:MITI), NPS Pharma (NASDAQ:NPSP), Sequenom (NASDAQ:SQNM), ViroPharma (VPHM) and Vertex (NASDAQ:VRTX) are just a few of the 29 biotechnology companies trading above their 200-day moving average at that time.

Consolidation

Merger and acquisition activity remains brisk and may also generate renewed interest in the biotechnology sector as U.S. pharmaceutical companies stand to lose billions of revenue from 2010-12 due to patent expirations. Pfizer (NYSE:PFE), Wyeth (WYE) and Merck (NYSE:MRK) have recently indicated that they are on the prowl for acquisitions. In addition, the challenging financing climate may force many small biotechnology companies to combine for survival. M&A activity over the past year includes, among others (acquirer/target): Eli Lilly (NYSE:LLY) / ImClone (IMCL), Takeda / Millennium, Roche (OTCQX:RHHBY) / Memory (MEMY), EUSA / Cytogen, Stiefel Laboratories / Barrier Therapeutics, and just this week – Endo Pharma (NASDAQ:ENDP) / Indevus (IDEV). Incidentally, both Endo and Indevus were trading above their 200-day moving averages at the end of 2008.

Investor Visibility

Upcoming conferences offer an excellent opportunity for biotechnology leaders to generate momentum for the industry in the year ahead. More than 300 companies will deliver presentations to thousands of investors next week at J.P. Morgan’s 27th Annual Healthcare Conference held January 12-15, 2009 in San Francisco. This event is the first and perhaps most important biotechnology investor meeting of the year, followed quickly by the BIO CEO and Investor conference held February 9-10, 2009 in New York.

On a more local level, and as the nation’s center of bioscience and pharmaceutical research and development, more than 300 members of New Jersey’s bioscience community will gather for BioNJ's 16th Annual Meeting held January 22, 2009 at the Hilton East Brunswick, New Jersey. Featured speakers include Barclays Capital Vice Chairman Frederick Frank and Biotechnology Industry Organization (BIO) President and CEO James C. Greenwood, the former U.S. Congressman of Pennsylvania's 8th District. For more information, visit the BioNJ website.

Conclusion

To be sure, the capital markets remain turbulent and there may even be casualties along the way among undercapitalized companies, but many of the biotechnology industry’s fundamentals, such as the number of products in clinical trials, new product approvals, profitable biotech companies and industry mergers & acquisitions remain favorable. Combine these positive attributes with yet to be seen benefits from decoding the human genome, an improvement or stabilization in the capital markets, greater resources for the FDA and a novel blending of technology, chemistry and biology and many of the necessary ingredients for The Biotechnology Revolution that I first proposed in December 1999 remain intact.

Disclosure: Author owns 4000 shares each of MITI and NPSP