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4Q Financial Markets Preview: Wing and a prayer

As might be expected in a volatile and nervous economic climate, biotech investors aren't sure where the markets are going, and prognostications for the fourth quarter reflect their uncertainty. The hope is for a 4Q in line with the trend for the last six years, but whether this quarter will follow or buck the trend is up for debate.

On one hand, many investors don't see anything in their environment - not the slowing economy, not spillover from the subprime mortgage crisis - that would prevent biotech from having its traditionally good fourth quarter. They are thus hopeful that upcoming milestones, along with the prospect of renewed M&A activity and the attraction of the sector as the rest of the economy slows, will propel the group to a strong finish (see "4Q Bounce," A2)

Biotech has already climbed up from an August bottom that had been largely driven by liquidation among computer-driven quantitative funds to cover similarly leveraged positions. Ballooning short interest also looked to be driving buyers ahead of a potential rally.

Investors are still worried, however, about all kinds of factors that could keep biotech from having a good quarter, including the broader economic and market environment, an M&A slowdown, and a string of clinical news that underperforms expectations.

August bottom?

A number of Street watchers think that August marked the bottom of the market for the year, with the Fed's Sept. 19 rate cut of 50 basis points punctuating the bank's determination not to let the mortgage crisis sink the economy. By this line of reasoning, the rate cut bolstered a biotech upswing that had already started in late August and early September.

Since the bottom in August, the BioCentury 100 has climbed 10%, and closed the third quarter with a gain of 6%.

The S&P, NASDAQ and Dow Jones all followed a similar trajectory, but ended up underperforming biotech (see "Slow and Steady," A9).

For biotech, the relevance of the lower interest rate is that "it makes long dated assets worth more," noted Stuart Weisbrod of Merlin Biomed. As such, it's "the only thing that could pull the money into small cap biotech."

Even prior to the rate cut, biotech buysiders could argue that stocks wouldn't go lower. "We already hit bottom earlier this summer," said Sven Borho of OrbiMed Partners. "I do think we're going to have a repeat of last year, with the strongest performance of the sector in the last half. Biotech per se has underperformed the general market - I think it's time for a rally."

"My sense is that the worst is behind us," agreed G. Steven Burrill of merchant bank Burrill & Co.

But others are less sanguine.

"There's a lot of uncertainty about which way

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