6:19 PM
 | 
Oct 05, 2018
 |  BioCentury  |  Finance

In sight of uncharted territory

How buysiders view risk of correction in 4Q18 as biotech indexes near all-time highs

Strong growth from small- and mid-caps coupled with a late run from large cap biotechs has pushed the sector within sight of its all-time high in 2015. Some buysiders now are seeing red flags of a possible correction: small- and mid-cap names that were overweight most of the year are now viewed as expensive, while a few investors are bemoaning the quality and early stage of new entrants as IPOs continue at a torrid pace.

However, the red flags aren’t serious cause for concern for most investors who talked to BioCentury -- at least not yet. Large caps remain cheap on a relative P/E basis and were the best-performing segment of biotech for the first time in six quarters. In addition, the data show there isn’t as much early stage risk in the 2018 IPO market as there was before the market peaked in mid-2015.

Moreover, while small- and mid-caps may be viewed as expensive, most specialists still see room to grow as stock pickers can find upside in select names.

“The sector has good momentum and that suggests we’re pointed in the right direction fundamentally.”

Brad Loncar, Loncar Investments

According to the buysiders, only macro risks could halt biotech’s upward momentum through year end. But the midterm elections in the U.S. are not top of mind.

“The sector has good momentum and that suggests we’re pointed in the right direction fundamentally,” Brad Loncar of Loncar Investments told BioCentury. “Anything that would jeopardize that calm could be a bad thing.”

Even if a correction comes, investors are confident that a record year of fund-raising has most biotechs well positioned to weather nearly any storm.

Testing the top

With biotech indices nearing all-time highs, some investors are starting to question whether there’s enough momentum to break through to new heights.

Companies and investors remember all too well what happened after the benchmarks peaked in July 2015 -- a 45% downturn that stretched through all of the following year.

The indexes have clawed back most of those losses. The BioCentury 100 ended 3Q18 about 9% below the July 2015 top and is up 16% this year. Similarly, the NASDAQ Biotechnology Index (NBI) finished the quarter about 8% below the July 2015 peak after having climbed 14% so far in 2018.

At least one major biotech index has already blown through its 2015 high watermark. In January, the NYSE Arca Biotechnology Index (BTK) shattered its July 2015 ceiling and had gained 27% through the end of the third quarter (see “Table: Index Performance).

Table: Index performance

Two biotech indexes are creeping closer to their all-time highs reached in 2015, while one has already blown through its ceiling. The NASDAQ Biotechnology Index (NBI) is within 8% of its July 2015 peak and the BioCentury 100 is closing to within 9% of its all-time high in July 2015. The NYSE Arca Biotechnology (BTK) index surpassed its July 2015 high in January and has since climbed an additional 21% through the end of 3Q18. (A) Change since inception on Feb. 13.

Index3Q18YTD18
NYSE Arca Biotechnology (BTK)13%27%
NYSE Arca Pharmaceutical (DRG)13%9%
NASDAQ Biotechnology (NBI)11%14%
iShares NASDAQ Biotechnology ETF (IBB)11%14%
BioCentury 1009%16%
Dow Jones Industrial Average (DJIA)9%7%
S&P 5007%9%
NASDAQ Composite7%17%
SPDR S&P Biotech ETF (XBI)1%13%
Loncar China BioPharma Index (LCHINA)-15%-3% (A)

With the NBI approaching its all-time high, buysiders were mixed on whether the sector is overvalued with a correction looming.

Three buysiders noted high valuations among small- and mid-cap names could be a sign the market could be approaching a top.

“Nearly all the asset classes are so expensive currently,” apo Asset Management’s Kai Brüning told BioCentury. “I wouldn’t say I’m concerned, but it isn’t a no brainer anymore.”

“There are definite warning signs.”

Ailsa Craig, International Biotechnology Trust

International Biotechnology Trust’s Ailsa Craig agreed some parts of the market may be getting overheated. “We’ve seen some really massive moves, really hard and really fast, in some big companies. As in 2015, there are definitely pockets in biotech that are overvalued,” she said. “There are definite warning signs.”

For example, 26 biotechs with current market caps above $1 billion have seen their shares jump more than 100% this year through the end of the third quarter.

Many have done so on the basis of positive clinical news, such as HBV company Arrowhead Pharmaceuticals...

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