Will biotech's bounce last?
There are reasons to think it might.
It’s been a tough year and a half for biotech stocks. But there are signs its fortunes may be turning. After plunging 62% from its early February 2021 peak to its mid-May 2022 trough, the sector as measured by the S&P Biotechnology Select Industry Index has rallied 34%, even after the past month’s broad market pullback. Slowing economic growth and possible recession (whether “official” or not, the Federated Hermes macro team sees the potential for additional negative real GDP prints over the next six quarters) don’t necessarily mean the biotech picture will get worse. In fact, relative to other growth sectors, biotech historically has held up well during periods of moderating-to-negative real growth. Part of this is because demand for health care, medicines and scientific progress rarely wanes just because economic growth does. Another reason: the Fed almost always starts to back off once it realizes the economy is headed into, or already caught up in, recession.
It's different this time, of course. The Fed has made clear that, with the labor market going strong, its focus is on its other dual mandate, price stability. Its overriding priority is to stamp out 40-year-high inflation, Chair Powell affirmed at Jackson Hole, Wyo., and there will be pain, he said, for households and investors alike. At this writing, fed futures are placing 78% odds of another 75-basis-point hike when policymakers meet later this month, and similar odds of a 4% fed funds target rate by the end of the year. As a reminder, that rate stood at 0-0.25% until mid-March of this year. The good news is that markets tend to be forward looking, meaning a lot of the damage from the aggressive rate hikes and the slowdown they are causing arguably has been priced in. That means that, with even the most hawkish Fed members indicating the bulk of the rate increases in this cycle should be over by year-end, valuation prospects should improve for biotech and other beaten-down rate-sensitive sectors.
To be sure, there will be challenges. A slowing economy in the face of elevated inflation is certain to squeeze profit margins and future earnings—an outcome Wall Street analysts have been slow to reflect so far in earnings forecasts. Moreover, two big drivers of biotech and tech generally—mergers & acquisitions and initial public offerings—slowed dramatically in the past year. But there has been some movement of late, with Amazon in July striking a deal to purchase primary care start-up One Medical for $3.9 billion and CVS Health this week announcing an $8 billion agreement to buy home health provider Signify Health. This activity hints that the broader macro and market environments may be turning constructive on biotech again and that, at the least, a bottom has been put in. If true, that would be a welcome development for long-term investors who have been wondering when to get back in or add to positions.