The biotech sector is no stranger to volatility. In recent weeks, the sector has received substantial criticism as it continues to sell-off while the broader markets hit record highs. In this piece we will examine potential reasons behind the downside, historical similarities and data based forecasts for the future.
For those of you unfamiliar, the XBI is an ETF which provides exposure to US biotech stocks. The ETF rebalances every quarter and focuses on a wide array of market cap sizes. As a result, many investors look to the XBI to understand how well the sector is performing and often compare their individual stocks to its performance as a benchmark. Since February 8th, 2021, the XBI has sold off from $173.99 to $126 as of April 12th, 2021. This -27% drop has taken place while the broader markets have set over 18 new record highs. While this performance is frustrating to many and amplified by the stellar performance of the broader market, this isn’t the first time the sector has experienced a prolonged sell-off.
Prior to the pandemic, biotech made headlines after immense sell-offs driven by potential drug price cuts discussed in the Senate in 2019. While bills have not materialized and have always faced intense scrutiny on the floor, investors became weary of these implications. Looking farther back, trade wars and other turmoil in 2018 created another sell-off. On a positive note, these sell-offs eventually lead to a recovery and oftentimes immense upside as the sector sets new all-time-highs. In addition, the sector appears poised for growth with the U.S. placing more focus on R&D. The recent proposed infrastructure plan, carves out $200 Billion for R&D in order to regain a competitive footing on the global scale. Fundamentally, the biotech sector stands to benefit immensely from these discussions.
The current theories:
The recent sell-off in 2021 has come with a lack of substantial news driving the action. As a result, investors are speculating on several theories behind the action.
- Rotation: Some investors believe a massive sector rotation has taken place. Evidence of this can be seen across various 13G filings across the sector which reveal substantial selling. Many funds appear to be selling some of their small cap biotech in order to position themselves for potential reopening and a post pandemic world. Amplifying this, fundamentally questionable companies saw immense market cap appreciation in response to wild speculation. To participate in this trend, many ETFs and Wall Street funds began heavily positioning in companies which are now showing a slim chance of contributing to pandemic efforts. With rising yields and a shift in focus to fundamentals, many of these at times lofty market caps are coming under scrutiny. These companies received wide scale support and focus and are now deflating with decreasing fundamental opportunity. As a result, a ripple effect has taken place through the sector as ETFs and investors attempt to reposition themselves in fundamentally stable opportunities with attractive growth prospects.
- Archego: Another theory behind the sell-off is correlated to the wild GameStop, Melvin and Archego squeeze. The massive margin call is speculated to be one of the largest losses of personal wealth in recorded history and is having ripple effect throughout various sectors. In this theory, some investors believe that funds impacted by these events, were forced to realize profits in biotech in order to provide liquidity for their clients and position themselves.
In reality, it is likely a combination of these theories which is contributing to the prolonged sell off. With funds re positioning, economic reopening coming into focus, margin calls popping up left and right, investors are more apprehensive with the biotech sector. On a positive note, historically this action is followed by a recovery and often a push to new all time highs in the sector.
Peak to trough:
Over the past sell-offs in 2018 and 2019, peak to trough shows us potentially more downside on the short term, but upside on a longer view. With an average retracement of -32% from the peak, the data suggests the floor is close to setting in. Historically these sell-offs have created favorable buying opportunities in fundamentally sound companies. Currently, several of our core positions such as BCRX have taken an immense beating on little to no negative news. Companies like KNSA have receded double digit percentage points on positive news like FDA approvals. While this price action is certainly frustrating and difficult to understand, history shows that this often results in equally and sometimes greater recovery when the industry receives some tailwind.
The bright side of a frustrating sector downturn like this is the opportunity to buy fundamentally sound companies poised for growth yet trading at a discount. During these times, we preserve capital and add to companies which are fundamentally executing, providing a better quality of life for patients, and are receiving little respect from investors in the present day. It may be a roller coaster type ride short term, but historically focusing on fundamentally stable companies at a discount yields consistent gains.
Good luck out there and feel free to reach out to our team if you have any specific questions or feedback. We’re standing by and happy to help our community members.