Is a Bust Coming in Biotech?

Real Concern or Groundless Fear?

Is a Bust Coming in Biotech?
September 26, 2014

After spending the better part of a decade in the doldrums, biotechnology stocks and funds started to break out at the end of 2011. Between November 2004 and November 2011, the NASDAQ Biotechnology Index rose just 243 points. But from November 18, 2011, to February 21, 2014, the index nearly tripled from 958 all the way up to 2,808 — a rise of 1,850 points in a little over two years.

This prompted concerns among many investment analysts that biotech had become the latest investment bubble, and that a biotech bust was imminent. Sure enough, the NASDAQ Biotechnology Index plummeted from 2,808 all the way down to 2,251 on April 11 — a fall of 557 points in less than two months.

But a funny thing happened next: The index proceeded to reverse course and shoot straight back up again, topping 2,890 in late August.

What Does This Mean?

So what are investors to make of all this recent volatility in biotech stocks and funds? Is biotech poised to make another run — or is the biotech bubble going to burst in earnest anytime soon?

Of course, no one can predict with certainty exactly what direction any segment of the stock market is going to move in the future. And bubbles are notoriously hard to predict — they only seem obvious after the bubble has burst. Think about the dot-com bust in the early 2000s: The handful of analysts who predicted it were ridiculed by the masses who thought we had entered a “new normal” in which technology stocks just went higher and higher, without interruption.

That said, there are a few things we can look at to help make an educated guess about whether or not a biotech bust is coming. First, let’s look at the reasons for the biotech surge over the past three years.

One of the biggest drivers is the spectacular recent breakthroughs in drug development. For example, Gilead Science has created a drug that cures hepatitis C, instead of just controlling it. And many established biotech companies have released promising clinical data that could soon lead to the launch of blockbuster drugs that could generate $10 billion a year in sales, according to one biotech investment analyst.

Another positive development for biotech stocks is the relative speed at which the Food and Drug Administration (FDA) is now approving new drugs after it slowed drug approvals in the aftermath of the Vioxx failure. The FDA has pledged to fast-track its review and approval of breakthrough medicines.

Also, consider the large number of initial public offerings (IPOs) of biotech companies over the past few years. There was a total of 45 biotech IPOs in 2013, which was followed by another 25 in the first quarter of this year alone. Finally, just spend 30 minutes watching an evening newscast on network TV and you will see commercial after commercial for new wonder drugs that can treat everything from erectile dysfunction to restless leg syndrome. (If you invest in pharmaceutical stocks, pay close attention to the side effects warnings on these commercials as you assess the benefit/risk profile of any new drug.)

What Should You Do?

Analysts who cover the biotech industry seem split as to the question of whether the biotech bull still has room left to run or biotech stocks and funds are headed for a bust. Therefore, the best advice for investors is to proceed with caution.

Perform the same due diligence on biotech stocks and funds that you would on any investment before purchasing it. For example, visit the company’s website and request or download a copy of its annual report. Also, obtain a copy of the business’ 10-K report for more detailed information about the company’s finances, operations and other critical aspects of the business.

In addition, be prepared for more volatility. The hair-raising rise, fall and rise again of the biotech market over the past couple of years is probably indicative of what the future holds for biotech investors — so buckle up and hold on tight.

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