2014 Financial Markets Preview: Hoping the pause is brief

What could keep biotech stocks outperforming in 2014 after blockbuster 2013

Bankers and buysiders are not expecting a repeat performance of biotech's stellar 2013. But the two dozen who spoke with BioCentury say the capital markets are primed to open back up this month, albeit on a more selective and price-sensitive basis.

The sector experienced a modest slowdown during the latter portion of 2013 due to a combination of profit-taking, deal fatigue and several high-profile setbacks that offered generalist investors a useful reminder of biotech's inherent riskiness.

Still, healthcare specialists suggest their generalist counterparts have not abandoned the sector, and will continue to chase the type of returns in biotech that are available in few other areas.

Indeed, profitable biotech's average P/E crossed 25 in 2013 for the first time since the financial crisis, which buysiders said shows investors believe the industry's recent performance is based on strong fundamentals.

Nevertheless, buysiders cautioned there may be some rotation into other sectors this year, with tech and consumer goods being likely candidates. A macroeconomic downturn or spate of bad industry-specific news could lead investors to more defensive sectors.

On the IPO front, bankers say test-the-waters meetings began ramping up at the end of 2013. The action is likely to heat up around next week's JP Morgan Healthcare Conference, with most Street watchers expecting more deals than in 2012, but fewer than last year.

Buysiders also have seen increasing interest in biotech among institutional investors in Europe, where companies did not enjoy the same financing bonanza in 2013 as their U.S. brethren.

The investors suggested European biotechs would be well advised to raise their profile in the U.S., where access to capital will continue to be much easier.

Measured growth

Biotech easily outperformed all the major indices over the first nine months of 2013, but regressed toward the mean in the last quarter.

Through Sept. 30, the BioCentury 100 index and NASDAQ Biotechnology index were up 49% and 53%, respectively. That compared to 25% for the NASDAQ Composite and 18% for the S&P 500.

In the fourth quarter, the BioCentury 100 added 7% and the NBI tacked on 8%, while the NASDAQ Composite rose 11% and S&P 500 added 10% (see "All's Well That Ends Well," A10).

"The sector was riding a wave of interest that continued through the end of September, then ran into some macroeconomic headwinds in the broader markets," noted Leerink's Rahul Chaudhary.

Chaudhary said generalists may have been reminded of the risks associated with biotech investing by a few commercial or clinical setbacks.

Among these was Ariad Pharmaceuticals Inc.'s temporary suspension of sales of leukemia drug Iclusig ponatinib in October, and November's news from Sarepta Therapeutics Inc. that an NDA submission for Duchenne muscular dystrophy (DMD) candidate eteplirsen would be delayed by at least two years.

"We had the reminder that investors are still exposed to risk, as well as deal fatigue after such a large number of IPOs and follow-ons, plus people had done so well and wanted to lock in some of their returns, which is why we saw the pullback," Chaudhary said.

Rather than suggesting biotech's impressive run has come to an end, the popular sentiment among bankers and buysiders is that the slide was temporary and the sector is primed for further growth beginning this month as investors return with more dry powder and a continued desire to chase returns.

"I think the correction is quite healthy," said Andrew Bogan of Bogan Associates. "If anyone trying to list new shares could command an arbitrary price with no thought to the odds of success, that would really concern me."

Bogan said it is hard to take a pessimistic view of equities in general given signs of strength from the U.S. economy, such as the recovery in the housing market.

"While I am not all that optimistic that biotech

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