By Michael Brush
“Biotech can definitely work when macro is tough.” (Genentech went on to be purchased by Roche Holding AG /zigman2/quotes/208994986/delayed RHHBY -2.30% .)
3. There’s more positive news flow
“As we start to see new leadership and real drugs that work and make bigger differences, that’s what gets people reengaged in the sector and moving back in,” says Gordon. “We need more of this. We need news flow.”
Possibilities here include updates this year from Alnylam Pharmaceuticals /zigman2/quotes/205655272/composite ALNY -1.69% , Roche and Karuna Therapeutics /zigman2/quotes/212846564/composite KRTX -4.02% on therapies for amyloidosis (excessive protein buildup in the body), Alzheimer’s and lung cancer, and schizophrenia, respectively.
4. Investors realize mass-liquidation fears are overblown
With the sector trashed, investors shy away on fears that dedicated biotech funds will have to close and liquidate their holdings, creating waves of fresh selling.
But history suggests this might not happen, says Borho, at OrbiMed.
“If you look back 30 years, every biotech bear market had some funds disappearing. They always work their way out over several quarters. A fund doesn’t just simply disappear. There are not going to be 10 funds going out of business at the same time. There will be one or two.” He says the fear of redemptions is “exaggerated.”
One reason is that investors remember that the health-care sector can post decent returns for years. They like to average down, especially into a lower fee structure, says Borho. Once investors figure out the mass-liquidation fear is overblown, it will calm nerves and help stabilize the group.
5. The ‘shorts’ get creamed by good news and move on
“This sector has been massively ‘shorted’ by quant funds and hedge funds,” said Borho. The SPDR S&P Biotech ETF /zigman2/quotes/205950134/composite XBI -2.07% and unprofitable tech were the two main hedging instruments over the past year, he says.
Positive news flow like more M&A and blockbuster drug breakthroughs could squeeze the shorts out. “This will be a first step,” said Borho. “The opportunity is there and it will be a surprise because sentiment is so bearish.”
6. There’s a cleanup in aisle six
Over 120 smaller biotech names trade below their cash levels, according to research by Yee. This is so unusual, it troubles potential investors. Some kind of cleanup to get rid of this red flag would help. Borho doubts these companies will close up shop and give shareholders the cash.
“That never will happen. Especially when you have venture capitalists on the board. They do not want to return the cash. They want another shot on the goal.”
Instead, we might see a wave of reverse mergers into these smaller companies that makes them more attractive.
“Companies are lining up to reverse-merge into public companies with a lot of cash. In some instances, I have seen 20 to 30 proposals to reverse-merge. You end up with a really exciting company again.”
7. The FDA normalizes
When Covid hit, the FDA pulled workers from drug approval to deal with pandemic therapies and vaccines. This led to more clinical holds, which shook up investors because it delayed drug development. “There is a capacity issue,” says Gordon. If Covid continues to recede, this issue could reverse.
Stocks to consider
Gordon at ClearBridge singled out Karuna Therapeutics, which has a schizophrenia therapy in late-stage development called KArXT. “I am a believer in that drug. If it is successful, that is a mega-blockbuster. And that is not priced into the stock.” He also likes medical technology companies, as hospitals ramp up non-Covid procedures because the pandemic is waning. Gordon did not cite names, but large-cap examples include Medtronic /zigman2/quotes/206816578/composite MDT -1.61% , Johnson & Johnson /zigman2/quotes/201724570/composite JNJ -0.61% , Cardinal Health /zigman2/quotes/206646342/composite CAH -0.42% , Stryker /zigman2/quotes/207664662/composite SYK -1.77% , Baxter /zigman2/quotes/207334572/composite BAX -0.90% and Boston Scientific /zigman2/quotes/203726728/composite BSX -1.39% .
Gupta at State Street Global Advisors singled out Vertex Pharmaceuticals /zigman2/quotes/202259802/composite VRTX -2.35% , which has promising therapies for cystic fibrosis, diabetes, sickle cell disease, pain, and kidney diseases.
Borho at OrbiMed says the one way to play the sector is to own a basket of potential M&A targets. “It’s tough to hit the real targets, but with a basket they go up together when we see M&A,” he said. He also singled out Natera /zigman2/quotes/208435998/composite NTRA -2.50% , a diagnostics company developing liquid biopsies that detect evidence of diseases in the blood, and the cancer therapy company Mirati Therapeutics /zigman2/quotes/209009887/composite MRTX -1.38% .
Michael Brush is a columnist for MarketWatch. At the time of publication, he owned KRTX and MRTX. Brush has suggested BMY, TPTX, BIIB, GILD, ALNY, KRTX, MDT, JNJ and MRTX in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.