BIOTECH INDEX DOWN
The summer has traditionally been a downer for the life sciences industry. Although in 2007 the DJIA has inched into positive
territory (about 2% for the year, and about 10% from July 2006 through July 2007), biopharmaceutical stocks have struggled.
In four of the past six years, the Nasdaq Biotechnology Index (NBI) has declined by an average of 14% in those years in which
the index fell. Through mid-August, the NBI is down about 2% for the summer months (so far).
Consequently, with a lousy track record in summer months, and a July–August market timeframe that has veered decidedly bearish
over the credit crunch, it's difficult to envision a scenario where biopharmaceutical stocks overperform. More likely, biopharmaceutical
stocks will continue to wilt in the late summer sun and hope for a comeback in the fall—or more likely, 2008. An optimist
would say that the biopharmaceutical market has no place to go but up. Bellwether industry companies like Genentech and Human
Genome Sciences were trading near or at 52-week lows in August, but I'd expect to see them continue to trade lower, tethered
to the misfortunes of the rest of the stock market as the credit and lending debacle plays out.
HOPING FOR A "SOFT" LANDING
This is why I'm down on biopharmaceutical stocks for the rest of the year. The credit crunch is a portfolio-crushing bogeyman
that has come out of the closet in the dead of night with mayhem on its mind. Hyperbole? Maybe.
It's just that, by and large, credit crunches are like hurricanes. They don't come around that often, but when they do, they
leave a trail of destruction in their wake. So on the surface, it would appear silly to tie the biotech market to the unraveling
credit markets. But, on closer examination, there's a strong bond between the two.
After all, what do biotech companies need more than anything else? A dependable and plentiful money pipeline. Operating capital
is the lifeblood of the life sciences industry. But in a period of "tight" money, where liquidity is difficult to come by,
biopharmaceutical firms will find it difficult to find the capital they need to keep going.
Investment guru Alan J. Brochstein, writing in his Bio Investor blog earlier this summer, said that the scenario is a painful one for biopharmaceutical companies—akin to keeping water away
from a man stranded in the hot desert.
"The linkages elude traditional finance theory, but they are quite clear," he wrote. "On the one hand, speculative biotech
companies are in constant need of capital (and capital's cost is going up). On the other hand, liquidity is shrinking and
the cost of owning risky securities is rising rapidly. The first point is rather obvious: Biotech companies in development
burn cash, causing them to sell bonds or stock to finance their future growth. When it gets more difficult to do, like now,
it puts them in a precarious situation of facing funding shortages or having to pay a higher cost."
Brochstein also said that the same guy saddled with a skyrocketing subprime mortgage bill every month is the same guy investing
in biopharmaceutical companies. That is, "same guy" being the hedge fund operators who have found themselves stuck holding
the bill for the subprime mess (hedge funds are big buyers of loan and credit issues). Needing money fast, the hedge funds
should be big sellers for the duration of the credit crisis. That means getting out of positions in other investments, like
biotech, to cover their losses in the subprime markets.
It is, I admit, a scary scenario. It's also a scenario that is already starting to play out in the financial markets. It explains
why the DJIA had three days in August where it lost more than 200 points daily. It explains why hedge fund managers, facing
nerve-wracking margin calls over their failed subprime portfolios, are big sellers of other securities.