Biotech Bear Market Trends

Bear Market Mentality Hits Biotech 

FBT 110.5 down 1.23% YTD

IBB $296 down 2.3% YTD

XBI $61.8 flat YTD

XLV down 4.74% YTD

Fidelity Select Biotech Fund (FBIOX) $212 down 4% YTD

Review Previous Articles on Biotech Market Trends

The vicious three month sell-off with the IBB down 20% over one month in the six year bull market has created so much psychological damage that a bear market could prevail at least until third quarter earnings gives us clarity. Add new positions with caution keeping in mind that selling prevails.Biotech stocks have been driven to extreme valuations by large hedge funds, investment banks and mutual funds who are primarily momentum investors with huge cash coffers.

We will continue with the “Biotech Market Trends” series adding some new elements to our model now that we have entered a bear market. Four out of five market trends turned negative as we wait earnings in October.The drivers of the 5 year biotech bull market have been: strength in the healthcare sector, M&A, growth from product sales and positive clinical developments. Now we have a change in fundamental factors to consider such as the following:

• The healthcare sector (XLV) and biotech does not have relative immunity to macro economic news and the overall market and certainly is not considered defensive. Biotech and healthcare stocks are now a laggard sector due a scary change in sentiment. Political uncertainty and a FED decision creates a pall that inhibits buyers.
• Pricing was a “sell” catalyst but five-year returns of over 232% drove profit taking on a massive scale.
• Looking ahead toward 2016, M&A may slow as valuations will be scrutinized and the potential for funding will slow with higher interest rates and a nervous high yield bond market. Our biggest winners in 2014-15 were buyouts: Astex (ASTX), Cubist (CBST) and Pharmacyclics (PCYC).
• Valuations now do matter and pipelines may be downgraded to a higher risk level.Emerging companies need to be concerned about long-term cash requirements.
• Life Science ETFs have created more volatility with rapid fire trading long and short.
• Time can cure a bear market and bullish seasonality is ahead. Wait for more clarity and buying interest.

We will not review our Biopharmaceutical Portfolio for new buys until we see a turnaround in technicals or positive earnings announcements for large caps.The following Rayno Biopharma stocks are up YTD as of 9/28: CLVS up 61%, FCSC up 51.7%, GILD up 3.1%, REGN up 12.1% and SGEN up 16%. Most others are down or flat. Stock picking will be more important with sector weakness.

We are hopeful that a Q4 rally will offer some recovery from this bear market turn. Retail investors and generalist funds are likely to avoid the sector until a solid trend develops. The large number of huge specialized funds would need to step in to reverse the course. At the bottom of the last bear market in biotech valuations were at venture capital levels but revenues from the major companies were still very low and most large cap biotech companies are on a solid financial footing.

Biotech stocks are prone to bubble behavior for many reasons primarily because medical breakthroughs such as molecular medicine and genomics are exciting with huge product potential. Low interest rates and fast money created speculative momentum which now has ebbed. In 2012 nobody knew about the bull market in biotech stocks and its underpinnings,but now all investors know about the bear market.