It’s no secret that biotech stocks and ETFs have been dynamite performers. Over the past six years, the iShares Nasdaq Biotech ETF (IBB) has soared over 290% compared with just a 88% gain for the SPDR S&P 500 (SPY). But like fashion trends, investing trends change — and not always for the better.
Since July 20, IBB has plummeted 23%, and the biotech group is officially steeped in bear market territory. Trading volume has been high and the selling pressure has been fierce.
Aside from historically high business valuations, political risk is the latest fear to strike the biotech sector.
Presidential candidates in the Democratic Party like Hillary Clinton and Bernie Sanders have turned hostile against biotech companies, insinuating they’ve been price gouging the public.
Adding to fears that Washington may take aggressive action against the sector is the investigation by Democrats on the House Oversight Committee into Valeant Pharmaceuticals International (VRX)’s drug prices. The stock has been clobbered, losing more than 25% in less than two weeks.
(Valeant drew fire after it bought the rights to sell two heart drugs, Nitropress and Isoprel, and then raised their prices by 212% and 525% respectively. Other drug companies have taken similar actions.)
The ugly performance of Orexigen Therapeutics (OREX) is another example of what’s happening in the biotech space. Last year the small-cap company which produces drugs to control obesity sported a market cap near $700 million. This year, its market size has melted down to almost $250 million.
A major risk of biotech investing isn’t necessarily a slowdown in R&D or a robust drug pipeline, but excessive leverage. For instance, Valeant had $30 billion in long-term debt at the end of June 30 compared to just $6.6 billion in equity. As capital markets dial back risk, borrowing and refinancing debt could turn into a major problem for the biotech sector.
Likewise, most biotech stocks are plagued by a lack of profitability.
Since biotechs are largely dependent on the success of clinical trials and FDA approvals – a process that takes a really long time – investors must keep companies afloat until they can generate sufficient sales to hopefully become profitable. But like the promising young actors that arrive in Hollywood seeking riches and fame, most biotechs fail, and prolonged decline in the broader stock market will put significant downside pressure on unprofitable biotech stocks.
While biotech bulls have enjoyed outsize gains in recent years, biotech bears are starting to clean up.
Since late July, funds that aim for 200% and 300% daily opposite performance to biotech stocks like the ProShares UltraShort Nasdaq Biotech (BIS) and the Direxion Daily S&P Biotech Bear 3X ETF (LABD) have skyrocketed between 51% and 117% in value.
The ALPS Medical Breakthroughs ETF (SBIO) is still holding onto a year-to-date gain near 16% and has been a rare exception of long biotech funds with a positive 2015 gain.
The fund invests in stocks of mid-cap and small-cap companies with a market size of no less than $200 million and no more than $5 billion. It holds 81 stocks within the Poliwogg Medical Breakthroughs Index and charges annual expenses of 0.50%. SBIO’s top holdings include Akorn (AKRX), Receptos (RCPT) and Seattle Genetic (SGEN).
— Check out Is This a Bear Market or a Correction? by Ron DeLegge on ThinkAdvisor.