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A look at the driving factors behind renewed optimism.
In our June column, we speculated about whether the XBI biotech index could be close to a bottom following the longest and steepest decline since its inception. On May 11, the XBI traded as low as $62.81, a level it essentially retested one month later on June 14. From its peak in February 2021 to this recent trough, the index has been in decline for 16 months and fallen nearly 62%.
Until recently. As of this writing (Ju=ly 19), the S&P Biotech ETF ($XBI) is trading over $83, for a one-month gain of over 32%.
So, what’s behind the move, and is it sustainable? Well, it is likely fair to say that valuations overshot on the upside in February 2021 and have reversed to unrealistically low levels in the downturn. Shorting of the group was likely overdone this year, as it was the only trade that seemed to work, until it didn’t, of course. So, yes, certainly short covering has been a factor. That said, there appear to be many other fundamental factors behind the move.
Sector specialists have been waiting to take advantage of the inevitable opportunities created by the carnage of a somewhat indiscriminate “risk-off” trade. The tide of rapidly rising inflation and interest rates took its greatest toll on long-dated assets like the early stage biotechs. A historically unprecedented number of preclinical/Phase I companies went public in 2020 and 2021 when record levels of funding flowed forcefully into the sector via IPOs and follow-on offerings. But the public markets for new capital slammed shut last year, and at the recent lows, about one-quarter of the companies in the biotech sector were trading below cash. While there has been a modest pickup in the IPO and follow-on markets of late, deal flow remains sparse and fairly tepid.
As would be expected, the larger, later-stage companies with greater liquidity outperformed on the way down but are now underperforming those that were hardest hit in the downturn, namely the earlier-stage companies. Given the shutdown in access to new capital in the public market, it is not surprising that companies with more cash outperformed on the way down and continue to outperform in the—dare we say?—recovery.
Investors remain optimistic about the sector and their appetite for risk tolerance appears to be increasing. They are seeking out companies with data readouts on the horizon across the sector with sufficient capital to reach them and view the risk vs. reward potential as highly attractive.
What is driving improved investor sentiment?
Here’s hoping for a better second half of the year.
Barbara Ryan is Founder, Barbara Ryan Advisors, and a member of Pharm Exec’s Editorial Advisory Board.