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What is Going on with the Biotech and Pharma Stocks?

by in Trusted Advice

Living in New Jersey, the Pharmaceutical Capital of the World, you meet a lot of people that work for either pharmaceutical or biotech companies.  Those are fortunate people, because in addition to working in an industry that generally helps improve the human condition, they have also benefited from a very nice multi year run up in their companies' stock prices.  That is a pretty good combination.

Well, at least part of that equation changed starting last summer.  While the market in general has been in and out of correction territory since then, Pharmaceutical and Biotech stocks have been especially hard hit (see 5 year charts below of the iShares US Pharmaceutical ETF -IHE and the iShares Nasdaq Biotechnology ETF - IBB).  The question many are asking is why?

 IHE 5 year chartIBB 5 year chart

Did a lot of promising drugs not pan out?  Did expenses go through the roof and profitability fall apart?  Did all of their best drugs go off patent?  While there have been some fundamental setbacks, nothing that would account for such a wholesale revaluation of the entire industry.  Then what has caused this?

Well, a big part of it can be summed up by one word: politics.  Towards the end of the summer, a scandal erupted that was tailor made for the tabloids.  The price of a previously obscure and off patent drug (Daraprim) was raised over 5,000% by its new owner.  That person Martin Shkreli, of Turing Pharmaceuticals immediately became Public Enemy number 1.  Drug prices were suddenly front and center in everyone's consciousness.  Democratic Presidential candidate Hillary Clinton quickly came out with a plan to control drug prices and Congress called hearings on the matter.  Suddenly drug companies were in the spotlight and not in a good way. 

 While something like this could generally be expected to blow over after the usual publicity gathering, events took an unexpected turn.  Instead of Hillary Clinton running for the Democratic nomination practically unopposed, Senator Bernie Sanders of Vermont started gaining ground and became a serious contender for the nomination from Clinton's political left.  This caused Hillary to tack away from the center to compete and caused drug pricing to stay on the political radar.  You could almost track the price decline against the polls and primary results.  And then, just when things looked like they were starting to stabilize, the Republican front runner, Donald Trump, began talking about drug importation and added it to his platform.  The drug companies were now getting it from both sides.  At this point it looks like the barrage may continue through November.

So what to do?  The fundamental picture for most of the companies is still very good.  The drugs in their pipelines are full of promise.  And now, many, but not all, of their stocks are trading at reasonable and even cheap valuations.  Especially compared to their future potential earnings growth.  Those where the pricing and fundamentals make sense we will continue to hold through the turmoil.  Where we perceive that the fundamentals or valuation no longer make sense, we will remove those positions from your portfolio.  However, if you own a sector ETF, you have to decide whether to buy or sell the whole industry.  This is where having a long time horizon and a well diversified portfolio of individual stocks gives you an advantage.  Instead of having to make a decision on the whole industry, as you would with an ETF, here at Covenant, we can use our over 100 years of combined experience and analyze each company one by one and decide whether the potential reward is worth the risk priced into the stock. 

 

 

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Guest Saturday, 22 February 2020