Biotech stocks sunk on Monday along with the broader tech sector.
Inflationary concerns and interest rates have put a downward pressure on the biotech sector for several months.
The Nasdaq declined by 521 points or 4.3%, at 11,623.25 points.
“Nothing has really changed in the thesis that biotech is undervalued at these levels,” Thomas Hayes, chairman of Great Hill Capital in New York, told TheStreet. “You're seeing pressure on the group until you get a few more prints that inflation has peaked and yields start to stabilize.”
Biotech stocks have been trading like tech stocks for the past couple of months, he said.
“There are more biotech companies trading at a discount to cash than we have ever seen historically,” Hayes said. “Over the past 20 years or so, every time you have a spike in companies trading at a discount to cash, you are at the bottom or near the bottom. It may take weeks or months to build the bottom, but the group should find some stability as yields stop going up.”
Biotechs at a Discount
The decline in biotechs is not an indication of another issue in the sector, Stewart Glickman , deputy director of equity research at CFRA, told TheStreet.
"I think biotechs today are getting caught up in the greater decline in the market lately," he said. "I don’t think it’s based on sector-specific trends."
Over 20% of the Nasdaq Biotech Index's 370 companies are trading for less than cash, which means these companies have about $20 billion in cash, but are only worth $11 billion today.
In the past, there were spikes of 10% to 15% trading below cash, “but this is the highest spike of the percent of companies trading at a discount to cash, “ Hayes said.
During the last four times the number of biotech stocks trading at a discount to cash spiked, the sector was at or near the bottom of a cycle, he said.
The biotech sector needs two catalysts - the Consumer Price Index (CPI) print on Wednesday will likely confirm that inflation is moderating (rising less than the 8.1% estimate increase year-on-year), similar to the Personal Consumption Expenditures (PCE) index coming in below estimates last Friday, Hayes said.
Some Biotechs May Be Targets
This will likely result in yields on the 10-year Treasury yield moderating and tech and biotech starting to stabilize, he said.
“When this happens, the 10-year Treasury yield will stop going up,” Hayes said. “The 10-year yield reached 3.19% this morning before backing off to 3.07%. You are not seeing the Nasdaq Biotech Index start to reflect that moderation as of yet.”
The volatility in the market is a function of margin calls and dislocated selling in tech that needs to “flush through,” he said.
This current cycle is similar to the 2016-2018 cycle when the market was in a tightening cycle and the Federal Reserve roll off the balance sheet with quantitative tightening. The Fed funds rate went from 0.25% to 2.25%.
“The last time you had a dislocation like this was in 2015-2016," Hayes said. "You had ~50% correction off the top on XBI in anticipation of the tightening cycle and then the biotech sector worked back up to new highs over the next two years during the tightening process,” he said.
During the 2016-2018 cycle, SPDR S&P® Biotech ETF ((XBI)) was able to work up to new highs within two to three years and rallied by around 140%, Hayes said. One way for investors to play this sector is XBI, which currently owns 157 stocks - the top four holdings are Alkermes ((ALKS)), Halozyme Therapeutics ((HALO)), Ionis Pharmaceuticals ((IONS)) and Iovance Biotherapeutics ((IOVA)).
Since only 15% of biotech companies ever generate free cash flow, it can be difficult for investors to pick a handful that will be next blockbuster company, he said.
The biotech sector is adequately capitalized for continued research and development, but some may be targets for larger pharmaceuticals in the near term, Hayes said.
“Big pharma has the cash and biotech has the innovation; it's a match made in heaven” he said. “As many players in big pharma have patent cliffs coming up they will need to buy innovation. A number of these innovative biotech companies will get bought out by big pharma over coming months and years.”
