A 2015 prediciton: biotech investing goes mainstream this year
Happy New Year, everyone. As I am sure you know, 2014 was another banner year for biotech stocks. The Nasdaq Biotechnology Index finished up 34.1%, which compares to 11.4% for the S&P 500 and 7.5% for the Dow Jones Industrial Average. Though we definitely had some interesting bumps along the way (thank you Fed Chair Yellen), our sector once again was the envy of the stock market. In fact, biotech has made a habit of leaving all other sectors in the dust for at least the last four years in a row. Here is a chart comparing biotech’s performance to the S&P 500 and Nasdaq Composite over that time (click to enlarge). It has truly been an amazing run.
Click to enlarge
Outperformance like that leads us to the obvious question, which is: can biotech keep it up another for year? Let me first say that the performance you see on the above chart was not a fluke, and while most valuations today are clearly on the expensive side, I do not think we are in a bubble scenario either. The reality is that biotech has benefitted over the last handful of years from many fundamental factors. They range from the way the Affordable Care Act has brought more consumers into the marketplace to the way companies have been creating real value through scientific innovation.
It is the innovation part I want to focus on because I am one of those optimists who believes we are still in the early stages of something very special here. The term “inflection point” is easy to throw around, but I do actually think biotech is reaching one in a couple of ways. Not only is the science leading us to amazing places lately, but I get a feeling from talking with people that the way biotech is perceived and understood by the broader public is fundamentally changing too. That's because it is becoming front and center in our lives.
This confluence of events is why my prediction for 2015 is: this is the year biotech investing goes mainstream.
Isn’t biotech mainstream already?
So the first question you might be asking is how can a sector dominate the stock market for four years in a row and not already be mainstream? While I cannot entirely explain it aside from the obvious fact that biotech is so highly technical, the reality is that this sector is still treated by most market participants as somewhat of a sideshow. Generalist investors and the public at large seek exposure to it, but they usually only do so through vanilla ETFs and mutual funds. I recently wrote about that phenomenon, and how it might be changing, here. What has been lacking is specific knowledge of the industry’s players and an awareness of where the science is heading. Another problematic issue is how these investors traditionally have only rented the sector, rather than owning it.
Amazingly, most professional investors and pundits on TV also do not know how to discuss biotech in much depth either. While they are usually somewhat familiar with the established companies like Amgen (Nasdaq: AMGN) and Celgene (Nasdaq: CELG), most know little about the emerging companies who are at the forefront of where most of the innovation is happening. To see what I mean, please watch this short clip that recently aired on CNBC because it is par for the course of how our sector is typically discussed. This is a highly respected and sophisticated investor, and as you can see, he is simply guessing when it comes to specific names.
I think this is an interesting clip because it perhaps shows both where the industry was, and where it could be headed. While the investor himself jokes about his own unfamiliarity with the specifics of biotech (which is indicative of the industry’s past) he is also very smart for having picked up on the fact that something special is going on right now, and so he wants to be a part of it (which is where the industry might be headed). Many other investors I speak with are also starting to feel something in the air as well. In other words, I think we might be in the early stages of where the distinction between biotech specialists and generalists might be starting to blur a little. And perhaps 2015 is the year it starts to happen in a more noticeable way.
What catalysts are going to change that?
At this point, you might be thinking I am just letting these recent years cloud my judgment. Surely a bubble will burst, or those mainstream investors will eventually move on for some other reason, right? At the risk of saying things are different, I really doubt the sector’s recent success will be fleeting. There are a few catalysts that are fundamentally turning in biotech’s favor.
1. First and foremost is that the innovation happening right now is too exciting to ignore, and it is also producing results that the general public can understand and relate to. One barrier in the past has been how biotech has produced a lot of incremental improvements. While that has added up to big things over time, it takes highly technical knowledge, and an eagerness to dedicate a lot of time following it, to be able to invest in something like that. In such a scenario, it is no accident how the industry has leaned so heavily on specialist investors
Contrast that with some of the big leaps we are starting to see from things like gene therapy and CAR-T. While neither of those technologies are proven yet, some initial results are producing cures where you would not normally expect them. Regular people understand and can relate to that kind of thing, and so I am not sure it will primarily be specialist investors participating anymore. In fact, many people at a recent Christmas party I attended, who would otherwise never know these things in a million years, told me about how they have been hearing about CAR-T in the news. People are hearing these things, relating to it, and wanting to invest.
2. Another reason biotech is becoming mainstream is because many of the big companies the general public follows on a daily basis are moving into it in a big way. A few popular examples are Google’s (Nasdaq: GOOG) new Calico division, what Apple (Nasdaq: AAPL) is doing with smartwatches and health apps, and the large investment IBM (NYSE: IBM) is making to push their Watson platform into healthcare. These three companies alone get hundreds of mentions on the financial networks each day. Therefore, as they focus more on healthcare, investor awareness of the entire field will only grow as well.
Not only that, but also the new healthcare products these companies are making have become a big part of our daily lives, and so people are thinking more about health topics in general. While electronic scales and phone apps that measure your blood pressure might seem like small steps, just imagine where the technology will take us in five or ten years. People are already becoming more aware of their health by the day, and that is likely going to grow by leaps over time. As the general population understands their own health more, they will also understand general biotech topics a little better as well.
3. Additionally, demographics are working in biotech’s favor. While many people have been concerned about the industry’s pricing power after AbbVie (NYSE: ABBV) signed its hepatitis C agreement with Express Scripts (Nasdaq: ESRX), there are other things that I think should outweigh those concerns.
First, the aging baby boomer generation in this country is reaching retirement. That presents a huge stress on our healthcare system, and it must be answered with innovative products from biotech companies. Second, the Affordable Care Act is good for business because it opens up the industry to a large base of customers it never had before. Third, you have so many markets around the world providing huge growth opportunities as well. All of those things are big positives, and I think they will outweigh any pricing concerns on individual products. I am aware of no serious estimate that shows global healthcare spending slowing down or declining over time.
What does this mean for us biotech addicts?
Now if this prediction becomes true and biotech investing does become mainstream over the coming year, it will have some obvious ramifications. For one, already high valuations will probably become outright steep so you might have to learn to live with that. Also, this amazing IPO market will likely to continue its march forward.
However, the biggest thing to watch is how much is now at stake, so the science needs to come through and produce great results. That was what burst the bubble in 2000, because expectations were way ahead of scientific reality back then. We can only hope the sector does not experience a repeat. While I think this time is much different, success is definitely is not a lock. It would be a huge blow if platforms like gene therapy or CAR-T crash and burn under any scenario, but especially at this time when so many people are watching. I hope that does not happen because it would be a setback at a time when capital can be put to so many innovative uses.
There is also one thing that the investors who are already here and have dedicated time to understanding biotech should keep in mind. Which is that your knowledge is in high demand right now, so congratulations and be sure to make the most of it. Any young person who knows biotech should have no problem landing a job at a fund or investment bank these days, if that is what you wish to do. Likewise, professionals who already manage biotech funds or are thinking about launching one will find that raising money right now is easier than it has been in a long time. My advice to everyone would be to think of ways biotech investing can be further simplified and packaged for regular people. Funds that target specific diseases, ETFs, and things like that could be a big hit.
For all of these reasons, biotech investing becoming mainstream is my big prediction for 2015. Maybe I am not going out on much of a limb, given how the sector has already been so hot.
What made me think about this in more detail is a great book I just finished over the holidays, The Innovators by Walter Isaacson. As he does a great job describing in the book, there was a similar point in time (when graphical user interfaces became reality) that computing hit a noticeable inflection point and really took off with the masses. It was a moment where computers went from being something only hard-core hobbyists understood to something the general public could easily grasp. While there are obvious differences between a consumer product like a computer and biotech in general, I really think this sector is on the cusp of something similar. Maybe 2015 will be the year that many more investors will appreciate biotech, and not just us hobbyists. We’ll see.
Who Am I?
I'm an individual investor from Kansas City. My focus is on biotech stocks, but I enjoy investing in all industries. I'm an old-school, buy and hold investor who believes the best way to outperform and grow capital is to own innovative companies with good management teams over the long-term. more>>