In a bull market that’s six-plus years old, bull runs in hot sectors become increasingly scarce commodities.
One sector that’s been the lead bull pulling this bull market cart forward is biotech.
But even this raging bull could be in need of a breather.
The biotech sector has been the top performer in the market over much of the past 12 months.
In fact, it has been the secret of many of the best hedge fund managers who have counted on the biotech boom to keep them delivering big gains.
In the interest of full disclosure, the Market Vectors Biotech ETF (BBH) is a current recommendation in my Alpha Investor Letter service.
I’m very happy to admit that.
After all, the biotech sector has enjoyed a stellar run over the past 52 weeks, surging nearly 40%.
Yet over the past month, this same exchange-traded fund (ETF) has actually tipped slightly into the red.
As the overall equity market begins to stall, could we begin to see the stocks leading the charge higher launch a substantial correction?
If so, does this mean that the bull run in biotech is over?
A Noisy Bubble Debate
A recent article in London’s Financial Times described current conditions in the biotech sector.
It highlighted the “noisy debate” of whether biotech stocks are now in a bubble, or whether we are just seeing a much-overdue correction within a larger bull market.
The Financial Times piece quoted advisors on both sides of the biotech bull run question.
Charles Heenan, investment director at Edinburgh-based Kennox Asset Management, argued that biotech is a bubble about to burst. As Heenan points out, “The sector can move quickly without much change to fundamentals. When it goes right, it goes very right. But when it goes wrong, investors could lose it all.”
On the pro-biotech side is Neil Woodford, fund manager of the namesake Woodford Investment Management. Woodford, the best-known fund manager in the United Kingdom today, is famous both for finding small gems to invest in and for having the best long-term track record among his peers.
Most importantly for us, Woodford is a big bull on pharmaceuticals and biotech.
Thanks to several big biotech winners, Woodford Investment Management has delivered a 16.9% gain over the past 12 months through June 30. That compares with a drop of 7.7% for the iShares MSCI EAFE (EFA), a key benchmark and broad measure of international markets, over the same period.
The Slowing Growth Factor
Still, there appears to be one major fundamental that’s dragging on biotech.
And that is the near consensus over a slowdown in growth for the group.
As Alan Clifton, chairman of the International Biotechnology Trust, pointed out:
“The biotechnology sector has enjoyed a period of exceptional performance over the past three years. In my view, value creation in the biotechnology sector will continue for the foreseeable future, though it may be wise to anticipate a more moderate pace of advance in the near term.”
If there’s anything an already-tired bull market doesn’t want to hear, it is the term “more moderate pace,” even if it is inevitable.
Still another negative sign is the number of initial public offerings (IPOs) in the sector — always a warning of a bubble forming in biotech land.
According to data firm Dealogic, there have been 22 initial public offerings in the pharma and biotech sector since the start of 2015. Those IPOs raised a total of $1.7 billion.
This reflects high investor appetite for investing even in money-losing companies. The willingness to take on such risks in speculative biotech IPOs is eerily reminiscent of the dotcom bubble.
That resemblance is not lost on investors looking to book the gains before everyone heads for the door at the same time.
That’s why so many investors took profits over the past few weeks.
My Biotech Takeaway
While there has been a big run higher in the biotech sector over the past three years, I do not think we are in bubble territory just quite yet.
In fact, I see the recent pullback in biotech stocks as merely tracking trends in the broader market.
Pullbacks from time to time in a high-flying sector such as biotech are simply a consequence of what happens when traders get more nervous about locking in big gains.
This is hardly unprecedented.
Many traders called the end of the biotech boom last spring when the sector pulled back 25%. But those who exited biotechs then have regretted it ever since.
And though I fully expect this biotech boom to end with a bust, I believe any pullback in the biotech sector today is likely to be an attractive buying opportunity in the context of a long-term bull market.
And this has as much to do with market sentiment as with objective valuation.
As Sir John Templeton put it:
“Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”
And with all the handwringing about the imminent collapse of biotech, I see little euphoria in the biotech sector today.
In case you missed it, I encourage you to read my previous column about viewing world currencies through the Big Mac Index.