Biotech Stocks Continue With Underperformance

The Dow Jones Industrial Average has gained an impressive 10.6% this year through the third quarter, the S&P 500 an even more impressive 14.7%, and the Nasdaq is up 12.1%. However, the Nasdaq Healthcare Index lagged these dramatically with a modest gain of only 4.2%, while the XBI biotech index, in stark contrast, fell 10.7% despite continued strong fundamentals.

That said, stocks of large cap pharma companies like Pfizer outperformed the broader indexes, clearly a function of the $33-plus billion dollars in first-year sales likely from the COVID-19 vaccine. Pfizer is up nearly 17% YTD, and Merck saw its shares rise almost 9% in one day early this month on news of a COVID therapy with partner Ridgeback Therapeutics.

Biotech stocks have been falling since their peak in February of this year as investors rotated from growth into value. The COVID-driven lockdown of the economy in 2020 decimated consumer discretionary stocks, and their depressed valuations were screaming for attention as investors discounted the prospects of “back to (more) normal.” Despite the underperformance, IPOs in the biotech sector continue at a stellar pace and follow-ons, while markedly slowed, are still getting done.

Clearly, the stock market winners in 2021 have been the beneficiaries of the reopening trade fueled by the availability of COVID-19 vaccines. Coming into 2021, these stocks were on their backs. The No. 1 performing sector in the stock market this year has been consumer discretionary, followed by industrials. Healthcare has come in dead last—the opposite of what investors experienced in 2020, as the economy screeched to a halt and all eyes turned to biopharma in hopes of its ability to deliver vaccines and therapeutics to save lives and the economy.

Biotech massively outperformed last year with record dollars going into IPOs and follow-on offerings leaving companies well-funded to continue to support the innovation renaissance clearly underway. New drug applications and FDA approvals continue at a record pace. But now, sectors like the airlines and other bellwethers of consumer discretionary are trading at record valuations. Could they be overextended? Just as biotech may have been heading into this year? Could the trend reverse? Inevitably yes, it’s what markets do.

Will we see a rotation back into growth and biotech? When? And what could drive it?

In addition to macro-driven rotation from growth into value this year, there were also headwinds for the biopharma sector ushered in at the start of the year by the Democratic “trifecta,” which added to its underperformance:

• The Biden administration’s targeted price reforms and a new leader at CMS who supported universal healthcare.
• New leadership at the FTC expressing views that were decidedly hostile to pharma M&A.
• An FDA in transition, which appeared unstable and inconsistent across its actions, has left sentiment on the agency decidedly negative.

Should we expect a shift in performance? If so, what could spark an upturn for biotech stocks?

• Recently, top Democrats are acknowledging they may have to peel back their drug pricing reforms in the US Congress, to get their larger social spending bill through.
• M&A could be accelerating. With the first week of October came Merck’s aggressive bid for Acceleron Pharma for $11 billion; and even with that, an activist is raising concerns that Merck is underpaying for the rare disease company.
• The top 12 companies have over $170 billion in cash and debt capacity to fund M&A, and biotech valuations have fallen.
• Most pharma executives point to M&A as core to their growth strategy and a top priority.
• September has seen three big pharma deals announced—the most since the pandemic began.

Are you bullish on biopharma’s prospects?

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