Last year the biotech sector delivered impressive gains, but it has been hit hard recently by bubble fears, potential regulatory risks, and pricing cap concerns. Is it better to cash out now or wait through the volatility?
The high-flying, top-performing sector of 2013—biotech—delivered impressive gains last year, on the back of increasing mergers and acquisition activities, expansion into emerging markets, increasing healthcare spending, mounting demand for novel drugs, and Obamacare.
However, this sector—which also enjoyed a strong bull rally over the past 5 years with gains extending to a stellar 257%—has recently been hit hard by bubble fears as the Fed unwinds its massive bond buying program.
This is especially true as the Nasdaq Biotechnology Index is currently trading with a PE approaching 400 and almost 94 times estimated earnings, which is considered to be quite an exorbitant valuation by many market experts.
Apart from concerns over valuation, market experts believe that the surging IPO volume is also a key warning sign for possible risks for this hot sector of 2013. US biotech IPOs have seen the fastest start to the year.
However, the biotech sector’s worst slump came on March 21, when it suffered the steepest decline since October 2011 on the back of political risks. The sell-off came as the Democrats in the US House of Representatives questioned Gilead Sciences Inc. (GILD) —one of the top US biotech companies—over the high price of its new hepatitis C drug, Sovaldi.
The product priced at $84,000 for a 12-week treatment is considered to be far too expensive and has brought in fears related to potential regulatory risk and pricing caps for the biotech sector. Strong pricing power is considered to be one of the foremost traits for the investment case for this industry.
Given the concerns over valuation and pricing power, biotech ETFs have been the worst performing ETFs in the past month with all of them posting losses in the double-digit range. None of the products in this space managed to survive the recent slump, though these ETFs are still trading in the green in the year-to-date time frame.
The most popular ETF in this space—Nasdaq Biotechnology (IBB)—has slumped 13.25% in the past month, with around 7% of the losses coming in the past week alone.
Other ETFs including NYSE Arca Biotechnology Index Fund (FBT), Market Vectors Biotech ETF (BBH) and Dynamic Biotech & Genome (PBE) have lost in the range of 10% to 14%.
SPDR S&P Biotech ETF (XBI) was the worst hit in this space, having eroded almost 16% in the past one month. While XBI took the past 12 months to clock a gain of 38%, the ETF has eroded almost half of the good work in a single month.
Despite the beating that the biotech sector has received in recent times, its long-term prospects still look promising. The sector is expected to witness continuing launch of new drugs, which will boost both the top and the bottom line of biotech companies.
Let us not forget all the above mentioned ETFs have added more than 35% in the past year and have gained more than 180% in the past 5 years.
This impressive outperformance is expected to continue going forward, so it might be best to wait through the volatility and remain a buyer of this recently beaten-down sector.
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