It Is Biotech Stocks' Time to Shine

"These are hard times for the biotech sector. Barely a day goes by without layoffs being announced somewhere in Boston or California, and there are still more than 100 biotech stocks worth less than the cash they have in the bank.

Yet there are also very clear signs that the worst might be over for the sector. For investors with a long-term horizon, a recent rally leaves plenty of room for further gains.

The most important reason to bet that biotech has bottomed has nothing to do with the industry itself, but with the direction of borrowing costs. Biotech firms struggle in a rising interest-rate environment because many of them don't expect to have a product in the market for years.

With Wall Street gearing up for rate cuts and Federal Reserve officials increasingly confident that they don't need to keep raising interest rates to defeat inflation, that all-important metric is looking more promising for the industry. To top it off, not only do falling rates lower the cost of capital for these companies -- they also solidify their exit path by increasing pharma's appetite for acquisitions.

Indeed, as Treasury yields have declined in recent weeks, biotech stocks have soared. The SPDR S&P Biotech ETF is up 20% in the past 30 days through Tuesday versus a 10% gain for the small-cap Russell 2000 index and a 5% gain for the S&P 500. On Wednesday, that trend gained steam with all three major indexes up over 1%, and bond yields falling after the Fed held rates steady and signaled cuts in 2024. The S&P Biotech index rose 4.8%.

Biotech's struggles owe much to a comedown from the hype the sector enjoyed during the mRNA-meets-low-rates bubble that popped in 2021. During that peak year, 111 biotechs had initial public offerings in the U.S., topping a total of 91 in 2020. By comparison, this year only 20 have had IPOs, according to Goldman Sachs. Clearly, it will take a bit more time for the industry to work through its hangover as hundreds of companies either go out of business or merge with others.

While there are still many long-shot science projects, there is also a lot of very exciting stuff happening, from new approaches to fighting cancer to gene editing to new psychiatric approaches. 

With pharma facing a range of financial pressures, from a large patent cliff to new drug pricing rules, the industry has no choice but to continue to shell out high premiums for good science.

According to Brian Abrahams and his team at RBC Capital Markets, cumulative deal value year-to-date is now at about $140 billion, the highest since 2019. An analysis of the deals shows that 90-day premiums are at about 61% on average and that there are 50% more interested parties in each deal on average this year. RBC also notes that biopharma cash levels remain near record highs at $199 billion, with trends toward lower dividends and buybacks signaling greater business-development appetite.

Tim Opler, a managing director at Stifel, says this turbulent period is reminiscent of 2002 and 2003 -- a time of high rates, massive pressure on pharma earnings and patent challenges. "Sentiment was dark and the thought was that the pharma industry would never recover," he writes, noting that pessimism was greatest in 2003.

 The Nasdaq Biotech Index subsequently tripled in value over the next decade.

Predicting near-term moves for the biotech industry is a fool's errand, but the industry looks like it may be turning a corner, suggesting the moment for long-term investors is now." [1]

1. It Is Biotech Stocks' Time to Shine. Wainer, David.  Wall Street Journal, Eastern edition; New York, N.Y.. 14 Dec 2023: B.12.