The fear that central banks will overreach in their efforts to curb eye-watering inflation with rate rises and send us spiralling into a global recession has investors reassessing their inventories and wondering which stocks will withstand the current and impending headwinds.
Depending on the therapy or service they’re bringing to market, biotech stocks are viewed as risky and can feature strongly on investor cull lists in tough times.
There is a persistent idea among some investors that biotech stocks are high risk and therefore likely to go the way of bitcoin and social media stocks in lean times.
Sector has seen better days
The flat sentiment is unsurprising, considering how unkind 2022 has been to biotechnology stocks, which are down on the Nasdaq -12.38% over the last year.
Investors seem to have turned against ‘story stocks’ – where worth seems based on good ideas and future potential rather than a tangible commodity.
“The Nasdaq biotech index has fallen to new lows,” says Alto Capital investment manager Tony Locantro. “Sentiment is as close to the bottom as you can get, with relentless selling all year.
“Some biotechs have seen well over 50% falls for no reason – it’s a negative spiral where selling begets further selling. There’s no positivity – shareholders are despondent and prone to capitulating.
“Tech stocks have crashed and Twitter has turned into a circus – and the tech correction has filtered into the biotechs. It’s just a function of the market that the sector’s on the nose.
“Positive advancements are not getting recognised – it’s probably the most lethargic biotech sector I’ve seen in my career.”
Crucial to society
And yet, when health innovation succeeds, it’s a win-win for all players.
There are several reasons why it’s a good idea hold on to your nerve, and your health stocks, in the face of a recession.
Unlike social media stocks – where it’s sometimes hard to perceive the social value of the enterprise, particularly when outfits like Twitter seem determined to prove that there is none – the health sector is crucial to society at all points of the economic cycle.
Indeed, because of the ongoing need for health innovation, shares in biotech and healthcare are regarded as defensive stocks, which aren’t affected by movements in the market to the same degree as energy or consumer discretionary items.
When you combine this utility with being in the right place at the right time – as we saw with the biotechs that cleaned up during the COVID-19 pandemic – the recognition dawns that, as long as the fundamentals are right, sticking with biotech stocks can pay off in the long run.
The war chest
In a recession, businesses undergo a transformation – with deflated demand, they may need to go into a kind of hibernation, cutting back on staff and production.
Businesses with a healthy war chest can afford to hold out for a better share price before they attempt to raise capital, so overextended biotechs that have been plunging cash into R&D might feel the pinch.
“Companies need to get on with what they’re doing and be cognisant that they’re going to have to raise capital at a lower price,” said Locantro.
“Smaller biotech will be forced to raise money and face up to some dilution but if a company is good enough, they’ll overcome it. The fear of a cap raise is much bigger than the cap raise itself.”
Play the long game
The clinical trials process for human-use drugs and therapies is necessarily long and relatively inflexible to external expectation, and exposed to the risk of the science simply failing at the end of years of expensive R&D.
It’s also a people-focused sector, at a time when social distancing and lockdowns would have limited access to people.
“Small caps still have to go through the trials process and there would’ve been difficulties in recruitment for clinical trials during COVID,” said Locantro. “We’ve seen two-to-three-year delays where the mining sector has been able to just get on with it.”
Investors in this climate prefer the sugar hit of a straightforward stock that delivers in the near term or at least holds its value.
“We need good investment in healthcare,” Locantro said. “Big pharma doesn’t care about market sentiment – if they see a good idea they’ll swoop. Major biotechs aren’t afraid to take over smaller companies. They’re cashed up.
“There are still big deals being done, with some good drugs and diagnostics coming through.”
The next COVID
The impact of the pandemic – both on the sector itself and on investor sentiment – is hard to calculate.
“COVID had a major impact on clinical trials and drug manufacturing for a couple of years,” said Locantro. “Many biotech staff have been unable to work in a team environment because of lockdowns.
“We’re only now starting to understand the impacts of long COVID, that’s going to drive a lot of innovation,” he added.
“There is talk of further waves – there are numerous health complications and we don’t know the long-term effects. That will, unfortunately, create some opportunities.”
And the complexities of health care don’t simply exist in a COVID bubble. The knock-on effects for other health innovations and related industries – think telehealth – are substantial.
What should investors look for?
In an uncertain market it’s hard to know when biotech’s current flat fortunes might reverse, but they will at some point.
“Some investors would be waiting for markets to settle, but they never settle,” said Locantro.
In the meantime, investors seeking a relative bargain should look for biotech companies with strong balance sheets that are:
- fielding a product that will treat indications with high unmet need in large markets;
- nearing the end of a successful trials pipeline and close to commercialisation;
- pursuing or have secured patents for their innovations; and
- licensed and approved in big markets – a Food and Drug Administration (FDA) green light speaks volumes.
“With the focus on drug delivery and saving lives, the sector represents amazing value on a two-to-three-year basis. Any company with good fundamentals, succeeds,” concluded Locantro.
“It’s still an awesome sector if you’ve got the money to buy.”