Biotech Rout Not Surprising: Surveying The Damage

Apr.11.14 | About: iShares Nasdaq (IBB)


Biotech stocks decoupled from fundamentals and ran on exuberance.

Bull Market is Intact but intermediate bottom not confirmed.

Top Ten Reasons For Sell-Off and too early to call next steps.

Top Ten Reasons For Biotech Correction

NASDAQ at 4022,IBB at 221

A Sentiment Driven Market

We have been writing about the bull market in biotech stocks since its inception in March 2009 when quality companies were advancing their pipelines and new products in immunology, oncology and infectious disease were being launched. The life science sector was relatively unknown to generalist investors even though overall stock performance beat the market from 2003 to 2008. Many underlying trends drove the stocks up over 250% over five years : new products, technological breakthroughs like targeted therapy and M&A. I wrote in September 2012, "Who Knows About The Bull Market in Biotech Stocks?" I wrote again in April 2013, "Is There No End To The Bull Market In Biotech Stocks"? How could anyone forecast at that time biotech stocks would soar 60% through 2013? But the big surprise came in January 2014 when the sector took another leg up as much as 20% before the current downdraft. Now that the biotech sector is relatively well known even by generalists here are some of the reasons given for the collapse especially with momentum stocks. We can elaborate on some of these next week after volatility ebbs.

  1. A rotation is underway from momentum to boring, growth to value, with large cap stocks like old tech-IBM, MSFT, CSCO -and energy-CVX and COP attracting buyers.
  2. The Waxman congressional letter on drug pricing provided a catalyst for selling as it is well known that biological products are expensive.
  3. Recent market data released by CMS on Medicare spending may have focused analysts on procedures and payouts. An issue going forward would be growth in healthcare vs other sectors.
  4. Profit taking by larger investors. Reversion to the mean. Presumably institutions ran stocks up in 2014 and had huge returns in 2013.
  5. MOMO players ran off the runway. This became evident when $1B market cap became the new norm on companies with no revenues. Many of these "high flier"stocks offered early clues as they were down 40% before the broad indices got hit.
  6. Concern about Q1 earnings among mid and large caps that are valued as growth stocks.
  7. Algos, robots, dark pools , HFT etc all the conspiracies of how the market works. Did they help create the bubble? Unlikely.
  8. Hedge fund and retail speculation. At some point in January the market took on a "1999" mood where piling on became evident. The IPO glut rattled the market and siphoning off funds.
  9. Market became more sensitive to valuations. Fundamentals caught up when market caps exceeded any imaginable 5 year forecast.
  10. All of the above. I will give you my top three as well as a rebalancing of our portfolio after Q1 earnings.

Some of these factors are potential long term issues but many have to do with traders reacting to sentiment and good news. But in a market environment where growth and yield is hard to find, many biotech stocks will be winners. Investors need to keep in mind that with emerging companies you are betting on R&D projects that require FDA approval. We will get back to old fashioned stock picking based upon technology and products. But we need time to digest the panic and we need to confirm a trading bottom. The bull market is intact.

Disclosure: I am long ABBV, GILD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long FBIOX Fidelity Biotech fund and short stocks on a day by day basis.