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Through the bulk of the growth stock-fueled bull market that now must be discussed in the past tense, biotech stocks and exchange traded funds were leaders.
Predictably, the race for coronavirus vaccines, which started in 2020, propelled biotech assets, but when those vaccines became readily available in 2021, it became clear that only a small number of biotech companies were credible contenders in this particular niche. As a result, biotech stocks slumped last year and those declines are carrying over into 2022.
For example, the widely followed NYSE Arca Biotechnology Index tumbled 13% last year and is off another 4% this year. Much of the recent lethargy in the space is attributable to shine coming off the coronavirus trade as well as concerns that the recently enacted Inflation Reduction Act, which allows Medicare to negotiate prices on select drugs, could be a drag on biopharma equities.
After two rough years, which is unusual in the biotech arena, there’s optimism biotech stocks and ETFs can and will bounce back – perhaps as soon as next year. Fortunately, that assessment isn’t solely rooted in hope. It’s backed by some decent fundamentals.
Assessing Biotech Fundamental Outlook
Again, optimism for a biotech rebound isn’t rooted in the point that the industry will likely finish 2022 on a two-year losing streak. Streaks, winning or losing, don’t have ceilings and aren’t valid reasons to buy or sell securities.
“Performance aside, hopeful signs are emerging thanks to more clarity on which drugs may be impacted by future anticipated price controls stemming from the recent passage of the Inflation Reduction Act, a robust pipeline of promising medicines and therapeutics, and a surprisingly resilient track record for the industry during periods of economic weakness,” according to First Trust research. “In our view, biotechnology is uniquely positioned to provide exposure to important innovations whose value may not be well reflected in equity prices today.”
As advisors know and should articulate to clients, the healthcare sector, including biotech, is arguably the most politically sensitive sector in the S&P 500. Politicians love to gloat about efforts to control drug prices and make bombastic claims such as “we beat pharma this year.” However, the reality is forcing drug companies into specific pricing on some products isn’t the effective tool politicians would have voters believe.
Owing to the expenses and time it takes to bring a new drug to market – usually billions of dollars and five to 10 years – too much political interference can disincentivize companies from developing new drugs.
“To recoup these outlays and earn a profit, drug companies may charge thousands of dollars for certain medicines, often causing ‘sticker shock’ when prices are publicized,” adds First Trust. “While history has shown that price controls rarely work as intended, often creating shortages and disincentives for investment, politicians sometimes find the temptation to propose such measures irresistible. Such has been the situation over much of the past six years.”
Innovation Matters
Moving past political clarion calls, advisors should remind clients that biotech’s reputation for innovation remains intact. In other words, one of the biggest fundamental factors in favor of biotech is still credible.
“Innovation is flourishing in the biotechnology industry as companies race to develop treatments for devastating diseases that impact millions of patients each year. As of January 2021, the biotech and pharmaceutical industries had roughly 12,700 projects filed with the FDA, a 33% increase from five years earlier,” noted First Trust.
One way of looking at the above is that if the FDA speeds up its approval process in 2023, which some analysts expect will happen, there could be legitimate catalysts for biotech upside.
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