Biotechnology 2007

Outlook for Biotechnology Investing 2007

Money flows into health care will benefit biotechnology

Rod Raynovich 2/1/07

Our expectations for 2007 are more realistic after a lackluster 2006 where the various biotech indices failed to surpass 2005 highs. Despite all the brainpower and experience managing healthcare and biotech funds, the returns were a meager 6% at the high end and an average of 1.2% for the health science category according to Morningstar.

Many mutual funds in the health care sector actually had negative returns when expenses were taken into account. Of course there may be hedge funds playing the sector that have huge returns because of their ability to create momentum, short stocks and concentrate their bets on a few speculative small cap companies.

For 2006 in the large cap sector, big winners such as CELG and GILD were countered with losers like AMGN and DNA. Among the small/mid cap stocks under one billion market cap , my index of 20 stocks is instructive. Despite huge winners like MYOG, ARRY and ALNY, the Index was down 10% as half of the stocks were in the red with ~50% losses due to failed clinical trials. The bellwether ETF IBB is still stuck near its 2004 and 2005 highs of 80.
A big concern for biotechnology is the high rate of drug failure in Phase III despite all the new discovery and development tools such as genomics.
With S&P returns of 15%, international and real estate sector returns of around 30% and natural resource plays in the 15% range, life sciences stocks could easily be ignored in 2006.

2007 should be a better year than 2006 for a number of reasons among them being:

  1. M&A activity will drive stocks with acquisitions of small and mid cap companies that have Phase II validated products or existing revenues. There are plenty of synergistic combinations to be played out.
  2. Money will flow out of hot sectors like cyclicals, energy, communications and emerging markets and find their way into life sciences especially if global economies cool. Liquidity will remain due to low interest rates.
  3. Despite all the rhetoric from the Dems on drug pricing pressures this not likely to be a factor as the industry offers good value both as investments with the large caps and innovative products in the pipeline of small and midcaps. If the politicians want to attack health care costs they should go after the 20-30% waste in the bloated bureaucracy much of it in“managed care” and insurance.
  4. New technologies and themes such as RNAi, targeted therapies, kinase inhibitors, immunomodulation, stem cells , smart vaccines, and genomics should finally improve drug development productivity and spur investor interest.
  5. As always stellar clinical developments and headline healthcare breakthroughs will drive stocks.

It is always difficult to make picks at this time of the year as many stocks are at their highs due to seasonal factors like small cap Q4 strength, the “January effect”, Life Science Conferences etc. so building a portfolio require a certain timing and trading acumen.

So with the goal of getting a 10% return in 2007 the following model is offered. Stay 50% invested in large caps, 25% in ETF’s or mutual/hedge funds and 25% in small and mid caps. Overall we see the sector at equal weight but overweight biotechnology within a healthcare portfolio.
Last year I got lucky picking leaders such as CELG and GILD so this year I’ll add some laggards like DNA with the following big cap line-up:

  • Another 20% in Exchange Traded Funds IBB and PBE
  • My mid cap picks are : ALNY CBST EXEL MEDX MYGN
  • My emerging Company/product picks are ARRY ILMN MNKD
  • Wildcards are AGIX and OSIP

Trading and rebalancing tips:

  • Watch daily MO and volume upticks; avoid stocks with chaotic or toppy chart patterns.
  • Establish core position then rebalance and add in weak Q2 -position portfolio for Q4.
  • Check out institutional holders of small and mid cap positions on Yahoo and NASDAQ sites.

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