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It’s been a long road down for biotechnology stocks. Following the bursting of the COVID-19 vaccine bubble, the S&P Biotechnology Select Industry Index is down 35.3% for the three years ending April 16.
Making that decline all the more ominous is the point that the broader healthcare sector hasn’t been all that bad. Over the same span, the S&P Health Care Select Sector Index – collection of the healthcare stocks residing in the S&P 500 – is higher by 22.6%. Making that scenario all the worse for biotech stocks is that during the three-year period, the S&P Biotechnology Select Industry Index was more than twice as volatile as its broader healthcare counterpart on annualized basis.
All of that is to say that biotech stocks have been enduring an unusually lengthy period of subpar performance – one that belies the industry’s innovative reputation and the fact that many stocks residing in the group are inexpensive.
A significant hurdle for biotech is high interest rates, which plague capital-intensive companies that need to access cash to fund research and development efforts. With hopes likely dashed that the Federal Reserve will lower rates in the first half of 2024, some advisors and investors are understandably apprehensive about biotech. On the other hand, there are factors that could support a biotech resurgence.
Innovation, M&A Key to Biotech Rebound
Despite slack equity performance, biotech remains a haven of innovation and that’s a good thing because that’s one of the primary reasons why some market participants are apt to consider revisiting the space.
Last year, the FDA approved 55 innovative therapies, well ahead of the 37 confirmed the prior year. Importantly, the needs addressed by those new treatments are expansive.
“Tackling challenging health issues that impact millions, these approvals include weight-loss drugs, Alzheimer’s treatments, mRNA-based vaccines to prevent respiratory syncytial virus (RSV), and advanced diagnostic tools for early cancer detection and new treatments,” notes Anqi Dong of State Street Global Advisors (SSGA).
As advisors know, another frequent catalyst for biotech equities has been consolidation activity, particularly large-cap firms gobbling up small- to mid-sized competitors. By some estimates, approximately 40% of big pharma’s current revenue will lose patent protection by 2030, indicating there’s good reason for those companies to replenish product pipelines via mergers and acquisitions.
“Biotech M&A activities picked up in Q4 2023, increasing the total M&A deal value for 2023 by 51% year-over-year and closer to 2021 level, despite there being fewer deals,” adds Dong. “The momentum has continued this year, with a flurry of deals announced in January.”
Favorable Cost of Admission
In bygone eras of biotech investing when these stocks consistently rose, valuations were typically well in excess of the healthcare sector and the broader market. That was simply the price of admission for accessing innovation and growth.
As rates rose and biotech stocks declined, valuations tumbled and appear compelling today, particularly when accounting for the strong balance sheets found in in the industry.
“Despite the strong rebound since late October, biotech valuations still appear attractive — close to their lowest level in the past 12 years, barring the recent rate hike cycle,” concludes SSGA’s Dong.
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