Reasonable rally

Why biotech's rally should continue in 4Q16, but not at the pace of the prior quarter

It looks like biotech's rebound will continue through the end of the year, but not with enough gusto to match the third quarter, or to make up for losses in the first half.

After the first half beating, an undercurrent of M&A and a bumper crop of follow-on financings that rewarded buyers with after-market moves led the sector to beat out the broader markets in 3Q.

Most specialists expect continued momentum on both those fronts. But macro issues are likely to cause volatility at least, if not a drag. These include the U.S. election in November and a likely interest rate hike the following month. As a result, a handful of specialists said they are sitting on more cash than usual - in some cases up to 20%.

Bankers expect that some larger funds, for which biotech is but one component, may sit out the next three months with the aim of starting 2017 from a lower base in order to improve their chances of breakout returns.

Moreover, healthcare fund flows remain negative on the year, despite a small inflow in September, suggesting generalists are putting their money into other sectors.

There may be reasons to come back before year end, as some other sectors are either topping out or ahead of themselves while the fundamentals for biotech are solid. In addition, sitting out could quickly translate to missing out if a steady stream of high M&A premiums causes a rethink of what biotechs are really worth.

"Valuations get reset quickly," said Sven Borho of OrbiMed Advisors. "People are starting to see that market sentiment was wrong because the strategic buyers are willing to pay up dramatically for assets."

Summer win

When the third quarter got under way, the table was set for biotech to continue the downward slide that characterized much of the first half. The June 23 Brexit vote increased volatility throughout the markets, and the July 8 clinical hold on the Phase II ROCKET trial of Juno Therapeutics Inc.'s JCAR015 made some investors wonder whether chimeric antigen receptor T cell therapies were ready for the regulatory spotlight.

Effects of both events were short lived. Stocks rebounded after an initial Brexit hosing, and FDA lifted Juno's

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