Biotech Correction: Just a market rotation or slower growth ahead?

Biotech Correction: Sell-Off Has Reached 10% over Three Months

Biotechs under pressure-has revenue growth slowed?

Technicals-a break through bottom channel. Need a bounce today.

Celgene is a bellwether. A buy in the $102 range.

Biotech stocks have been weak since Q4 earnings were reported and despite gains of about 15% or more year-to-date (IBB), warning signs have arisen that question the secular bull market in biotech which has run since 2009. Then there is a risk for biotech should the overall market particularly NASDAQ gets hit with a major 10% correction. Transitory correction or broken growth model?

XBI SPDR S&P Biotech ETF daily Stock Chart

Here are some major concerns:

  • Technicals are very weak with all gains in the IBB getting wiped out since the mid-August bottom. Although we came off the February 2016 lows we are 25% lower than July 2015 highs, but still up 135 % over 5 years. However XBI is much better almost hitting July 2015 highs in Oct.
  • Biopharmaceutical revenue growth has slowed as exemplified by the 25%+ stock hit on the Celgene (CELG) earnings announcement. Moreover generic competition is coming for blockbuster biotech drugs and many large cap biopharmaceutical companies have slowing revenue growth.
  • In the current bull market over the past five years both the S&P (SPY) and the (QQQ) show steady appreciation beating the IBB. The (IHI) Dow Jones US Medical Device ETF also shows steady appreciation of 162% over five years and 29% YTD.
  • Drug pricing rhetoric and healthcare reform are a potential long term threat to the drug industry.The threat of “repeal and replace” of ACA and less subsidized health exchanges (HIX) means fewer patients and is potentially another negative.

Here are some potential positives for the near term:

  • Seasonality for biotech tends to be good from November-January and several upcoming major healthcare investment Conferences should bring in buyer interest. But specialized institutional investors would need to step in big because retail investors cannot lead the market.
  • Recent weakness can be attributed to “robotic” technical trading from an overbought overvalued market in mid-October. This could reverse if mysterious “algorithms” trigger buying.
  • Small and mid-cap stocks are still driven by clinical development news and M&A. Funding is readily available for smaller companies and product breakthroughs and innovation should continue. The small cap weighted XBI is still up 35% YTD despite a 9% correction over the past month. Since the XBI is equal weighed not price weighted it should be less sensitive to earnings.

Innovative core technologies such as CAR-T, gene therapy and personalized medicine are creating better therapies for cancer and immunological diseases. The cost of new drugs is of some concern but product breakthroughs are likely to continue. There is no end to innovation in medical technology but with healthcare  costs rising and healthcare policy in turmoil, affordability has become a major issue.

Yesterday we saw some end to the selling as both major ETFs appear to be bottoming. Celgene (CELG) is also holding the $100 level as is the large cap weighted IBB. We track many stocks and the green screen has returned with many small caps bouncing.Lets see what happens when NASDAQ is strong and whether biotech stocks can follow.

Investors in healthcare still have several options. Traders can do well long and short with individual stocks as multiple opportunities arising on a weekly basis. Passive investors can let the correction run its course and add one of the excellent life science funds we have covered over the past year or buy a biotech ETF like the XBI. It is important to have some allocation of your portfolio in the healthcare and life science sector.

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