The correction has been steeper.
Funds are selling, high frequency traders are selling.
But disease is still the same disease, germs are still the same germs - if not worse.
Nothing is going to change the fundamental truth about medicines - that most of them are necessities, while some of them are luxuriously priced necessities.
Large cap growth stocks look particularly attractive based on valuation.
Life is a tug of war between light and darkness. As long as there's balance, there's life.
~ ancient Indian saying
A number of factors came together and caused the sharp biotech sell-off starting mid-September. However, that sell-off was precipitated by what has become known as the Hillary Tweet. That tweet itself, "I will reduce drug pricing if I become President," wasn't what scared the market as such; but the real possibility that a Democratic win may be bad for business.
Between September 21 and September 30, the iShares NASDAQ Biotechnology Index ETF (NASDAQ:IBB) fell nearly 15%.
People were doubtful about biotech even before that tweet. People felt that the multi-year rally in the sector wasn't sustainable. Things went south for a while, but then the sector rallied back a little, probably because the correction provided bargain hunters some buying opportunities.
So: have we left the air-pocket behind? Was the sell-off then just a correction, and have things now stabilized? Or are there worse things to come?
Five Reasons for the Sell-Off
If you take a look at the reasons for the sell-off, you can probably figure out that most of the reasons here are temporary stuff.
Clinton's tweet triggered the sell-off in biotech, pushing an already shaky sector over the brink. A co-factor might have been the long rally. People were wary that some bad news would come and stop that rally - and along came Hillary with her bad news. Apparently, people don't like continuous good news; a multi-year rally brings out the pessimist in us. That's precisely what turned people's sentiment against biotech, and they began questioning the "rich" valuations along with Clinton's questioning the "rich" pricing.
I have said again and again, like in race, creed, class and caste, generalizations don't work well in biotech. Every company is doing its own thing, and every company needs to be looked at individually. You shouldn't be saying - the entire biotech sector is overvalued. That's a nonsense generalization. Yes Axovant (NYSE:AXON) may be overvalued, but is Gilead (NASDAQ:GILD) at $90 and Amgen (NASDAQ:AMGN) at $150 overvalued? Absolutely not. These stocks are cheap buys at these bargain prices. If the entire sector was in a bubble, these stocks would be priced twice, thrice those numbers.
But people who don't understand biotech - but have a lot of money - run the markets, and when they panic sell, things begin to fall apart. The trick is to hold your head above the water and last it out.
A correction every now and then is not such a bad thing. The last time the biotech sector saw a correction was in February 2014. The IBB saw a sharp pullback between February 21 and April 11 before the rally resumed. The IBB not only regained the levels it had been trading before, but in fact rose to new highs over the next year or so.
The second correction in the sector came in July this year and continued through August amid turmoil in global markets due to China's decision to devalue the yuan. The markets and the biotech sector stabilized towards the end of August.
The latest fall has been steeper; I will give you that. But consider this: this correction came towards the end of the third quarter. Traditionally, that's when funds do a bit of window dressing, reduce their stake in biotech, make like they are actually doing something for their befuddled customers. Although I will get precise data next month only when they file their 13Fs, I strongly suspect this was one of the causative factors in the sell-off.
These things might have triggered another proximate cause - panic selling from high frequency traders. I am sure these traders have standing instructions based on charts - if this stock goes below this level, sell, sell, sell. And so also for sectors. So when Clinton and the funds and people's negative sentiments got together and pulled the sector below that level, these traders went on high gear and started selling.
These are people who make their buy and sell decisions based on chart patterns rather than science, or even fundamentals. Sometimes, they may not even know the entire name of a company, just the ticker. But they have power; they can move the market up or down significantly. I like them because they provide liquidity to the market, but I can't stand their wild mood swings.
So we have Clinton, we have naysayers, we have funds, and we have chart groupies. We also have another usual suspect - the Feds. Yes, the potential rate hike by the Federal Reserve before the end of this year may have caused some selling. When we have low interest rates, risk assets like equities are more appealing. When interest rates hikeup, or there are rumors that they might, people scramble for cover in gold or whatever. As a result, biotech suffers.
Of all these reasons and causes, only one, Hillary Rodham Clinton, aka lower drug pricing, may have a long-term negative impact on the biotech industry.
Or it may not. Presidential wannabes spend 99% of their time giving us rhetoric about changing reality, while real Presidents spend 99% of their time compromising with reality. It is good if she ruffled some feathers and made some waves. But after all is said and done, feathers will get unruffled, and waves will subside, some biotech will offer some discounts, President's will volte face from pre-nomination rhetoric, and life will go on.
Considering that several high priced drugs are already offering steep discounts, I think that process has already begun. Gilead for example offers a steep discount on Harvoni and Sovaldi. This week, Amgen and Regeneron (NASDAQ:REGN)/Sanofi (NYSE:SNY) also reached an agreement with Express Scripts (NASDAQ:ESRX) for their PCSK9 inhibitors. Both, Repatha and Praluent will be available at a discount to Express Scripts members.
What's there to complain about?
So, bottom line…
As I just said, only drug pricing could potentially change the fundamental picture of the biotech industry. However, that's not going to happen in reality. All other factors are transient and will pass.
Therefore, the sharp correction is a buying opportunity.
That's true not just for investors but also for biotech majors. Watch out for more M&As given the attractive valuations. In fact, deal making activity in the healthcare sector as a whole has already reached record levels this year.
In terms of valuation, the large cap growth space looks especially attractive. Gilead for example is now trading at just 4.5x estimated sales for 2015. This is well below the average of around 10x sales for the biotech industry, according to data from Stern, and Gilead's own average price to sales ratio for the last five years of around 6.7x.
Amgen currently trades at just around 5x estimated sales for 2015. The company's average multiple for the last five years has been around 5x, however, this is well below the industry average and also below the multiple for its peers.
So, when chart trolls and funds say sell, discerning biotech investors quietly buy undervalued biotech and wait for their turn. That's how it's always been, that's how it will always be.
Disclaimer - this author, as a medical professional, strongly supports generic and cheap medicine, but as a biotech investor, strongly supports market-controlled pricing, and is happy to remain eternally confused by the contradiction in those two positions.:)