Biotech Performance Pivot May Be in the Offing

Barbara Ryan, Founder, Barbara Ryan Advisors

In my column in the last issue of Pharm Exec, I wrote about the fact that the US economy added substantially fewer jobs in July than expected, making a September interest rate cut more likely. Specifically, on Aug. 2, 2024, the Bureau of Labor Statistics reported that the US economy added 114,000 jobs in July 2024, a sharp decline from June and well below expectations for about 175,000 jobs. The Fed’s rate hikes, aimed at taming the economy and inflation, have crippled biotech valuations and choked off supplies of new capital into the sector. If the desired objective of cooling off both is achieved, a Fed pivot to rate cuts could mark a substantial launch of biotech outperformance, as the XBI index has been inexorably and tightly inversely correlated with the direction of travel in interest rates. This pivot should usher in a long anticipated and potentially significant outperformance for biotech stocks.

Following a more than three-year bear market for biotech, the XBI appears to have hit its trough in October 2023 of $63.80, for a steep and painful decline of 63.5% off the-all-time high of $174.79 reached in February 2021. Since then, the index has begun to move ahead and now stands at $98, down from recent highs just over $100 in July and ahead 9.6% for the year, still lagging the 14.7% gain for the S&P 500.

On Sept. 5, 2024, the Bureau of Labor Statistics reported that the US economy added 142,000 jobs in August along with downward revisions to the prior two months, totaling 88,000. According to Michael Darda, chief economist and market strategist at Roth Capital Partners, “with the labor market losing steam and inflation expectations on the descent, the Fed is falling behind the curve.” He adds, “the unemployment rate suggests that the US economy is either in recession or on the cusp of one.”

In Darda’s opinion, “the most likely course for the Fed would be to cut by 25 bps on 9/18 (tomorrow) and signal that additional cuts would be forthcoming and that larger cuts could occur if the 'totality of the data' supported such a course of action.”

Darda goes on to say, “Perhaps risk markets are starting to have a “Wile E. Coyote” moment, as sky-high valuations collide with the reality of a weakening business cycle and a Fed that is highly likely to be behind the curve for the balance of the year.”

If so, investors will likely rotate aggressively back to biotech with a positive springboard effect on valuations and relative performance.

Meanwhile, biopharma fundamentals remain solid/positive and are now complimented by greater conviction that rate cuts are inevitable. M&A activity continues to be strong, both in the private and public markets, with the number of public deals over $1 billion, totaling nine so far this year, and while likely to fall short of last year’s record of 20, it is still an impressive pace. More than $25 billion has been raised this year across >25 biotech venture firms year-to-date. Private M&A deals are running high in 2024, with 12 acquisitions of greater than $750 million announced—which is two times the previous record in 2021. This is likely, in part, a function of the fact that more companies lack the opportunity to tap the public markets through an IPO, and venture funds are more willing sellers.

The IPO market remains sluggish, and seven of the 11 companies who have gotten out this year are trading below their IPO price, with five of them down 60% or more, according to Brian Gleason, managing director at Raymond James. That said, according to Gleason, the secondary market is very strong with $28 billion raised thus far this year, second only to 2020 at this same point. Gleason also points to the recycling of capital as another positive note for the sector—with 20 of the most active funds in the space collectively owning more than $20 billion in the companies acquired this year.

The sector does remain bifurcated, with the micro caps still undercapitalized—with 66% of them with less than 12 months of cash. This segment of the market has fueled record numbers of reverse mergers, restructurings, shutdowns, and public strategic reviews.

Raymond James also did a recent survey of biotech investors and found that 60% are more bullish and the majority expect the upcoming presidential election to have no material impact on biopharma stock performance.

Barbara Ryan is Founder, Barbara Ryan Advisors, and a member of Pharm Exec's Editorial Advisory Board