Here Is Why Biotech Stocks Just Exploded Higher

On the back of extremely heavy volume, Biotech and Pharma stocks soared moments ago, following yesterday's surprising weakness. What was the catalyst? As it turns out, Medicare spending didn’t trigger initiation of the Independent Payment Advisory Board to slash costs, a relief for the beleaguered drug industry whose shares have slumped since the start of the year.

• MEDICARE `IPAB' COST PANEL NOT TRIGGERED THIS YEAR, U.S. SAYS

Ironically, this happens even as the Medicare Hospital Insurance Trust Fund announced it would run out of funds two years sooner than expected, and will have sufficient funds to cover its obligations through 2028, two years earlier than previously projected. Social Security's retirement and disability trust fund reserves are projected to be exhausted in 2034, the same year as previously estimated.

Clearly focusing on the positive near-term impact, and ignoring the woeful situation on the tail end, biotechs not only recovered yesterday's losses, but have soared 2.7% as of this moment.

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Allegedly this removes a potential pricing overhang over the entire sector. This is how Bernstein previewed today's Medicare event:

On April 25th we wrote a report on IPAB, which stands for the Medicare Independent Payment Advisory Board. This is the entity that, under certain circumstances, has the power to propose/implement cuts to the Medicare program if a certain spending threshold (the “trigger”) is met. We said that the trigger determination would likely occur somewhere in the late May to July timeframe.

Our latest information is that the trigger update is likely to come this week per industry contacts. Based on precedent, this could get announced simultaneously in two ways. The Centers of Medicare and Medicaid Services (CMS) would likely describe it as part of its annual Medicare Trustees Report that discusses many different aspects of the Medicare program, one of which is IPAB. And, there may be a separate, stand-alone press release from the Chief Actuary of CMS announcing whether the IPAB trigger has been met.

Why does this matter? It matters because IPAB has far-reaching authority to lower Medicare spending by recommending cuts that could impact a variety of stakeholders, but none of this is spelled out very clearly in statute, meaning there is uncertainty about what IPAB could propose exactly. Nonetheless, many Washington insiders have felt that the pharmaceutical industry could be in the cross hairs, but here too there is uncertainty. In terms of the magnitude of any potential cuts recommended by IPAB, this depends on how far projected Medicare spending is above the predetermined threshold, but it might only be a smaller amount (in the context of how big Medicare spending is). However, the uncertainty attached to this could spook investors.

But, today's positive report is enough to spark a relief rally for now, although we note that IPAB is still expected to be introduced in 2017, according to the 2016 Medicare Trustees Report released today. As Bloomberg notes, "a controversial cost-cutting mechanism created under Obamacare, known as the Independent Payment Advisory Board, or IPAB, is projected to be triggered in 2017, the same timeline as predicted in last year’s report by Medicare’s Board of Trustees."

Investors had been watching nervously for news of the IPAB determination, fearing that it could have been triggered this year and setting in motion reductions in Medicare payments to biotech and pharmaceutical companies. The Nasdaq Biotechnology Index of 189 stocks has fallen for 11 of the last 13 trading days, including Wednesday. The index was down less than 1 percent at 9:57 a.m. in New York.

The IPAB is a 15-member panel that would be appointed by the president and has broad authority to propose cuts to payments made through Medicare. Congress, which has typically controlled many aspects of Medicare’s payments through legislation, has limited oversight of the IPAB, which was set up specifically to make reductions to U.S. health spending, at a distance from lawmakers and lobbyists.

Once appointed, the board proposes cuts to Medicare payments that will bring Medicare back under target levels that are based on rates of consumer inflation and U.S. gross domestic product. Those cuts are then sent to the president and Congress for fast-track consideration, though it’s not clear how the IPAB’s operations would fare in the face of what could be strong opposition or a legislature determined to fight its conclusions.

Lawmakers on both sides of the aisle have expressed concern, and House Speaker Paul Ryan would abolish the board in his proposed health-care overhaul, released this week.

Investors will have to wait until next year to see if the panel is triggered. If the rate of U.S. health spending slows, it may not be.

For now, however, the short squeeze is on, and in a blink of an eye, the Nasdaq went from flat on the day to up 0.5% with the healthcare and biotech sectors surging.