A Biotech Bounce Could be Marinating Right Now

There's no getting around it: the healthcare sector is disappointing this year, and within that group, biotechnology stocks have been obvious offenders. No, the returns aren't terrible. The Health Care Select Sector SPDR (XLV) is higher by 7 percent year-to-date with that figure dipping to 6.3 percent for the iShares Nasdaq Biotechnology ETF (IBB), but the Russell 1000 Index is higher by almost 21 percent this year.

The $6.70 billion IBB, which tracks the Nasdaq Biotechnology Index, is showing some signs of life as highlighted by a 4 percent gain over the past week. A few days don't make or break a trend, but every redemption story has to start somewhere, and with the fund laboring more than 11 percent below its 52-week high, the potential is there for IBB to deliver some upside into year-end.

Perhaps surprisingly, IBB's recent bullishness has come against the backdrop of political wrangling, a scenario that frequently affects biotechnology and pharmaceutical stocks. Earlier this week, House Democrats passed Speak Nancy Pelosi' (D-CA) drug pricing legislation, which the Congressional Budget Office (CBO) estimates would save Medicare $345 billion annually from 2023 through 2029.

Senate Majority Leader Mitch McConnell said the bill be "dead on arrival" with the GOP arguing that profits wrested from pharmaceuticals makers will stifle the development of new drugs, perhaps to the tune of 15 treatments per year.

Pushing Politics Aside

With 2019 drawing to a close, the 2020 Democratic presidential nomination campaign is about to shift into a higher gear. It's reasonable to expect drug prices will consistently part of that debate, but IBB's recent price action suggests large-cap biotechs can weather that storm and that investors may focus more on the value opportunity currently being presented by pharmaceuticals stocks.

IBB currently trades at 21x earnings. That's a premium to the broader market, something biotechnology stocks usually sport, but by the fund's historical standards, IBB actually looks attractive here.

"Morningstar's analysis points to pharma and biotech as the most undervalued industries in the healthcare sector, in large part because of continued overhang from U.S. drug pricing reforms coming out of Washington," said the research firm in a recent note.

Fortunately, the overhang of politics isn't likely to result in substantive legislation anytime soon, meaning some of the clouds facing the biotech sector could be poised to clear.

"From a political standpoint, with the election approaching, we see little incentive for meaningful bipartisan cooperation that would be necessary to pass any major drug pricing legislation," said Bank of America Merrill Lynch analyst Geoff Meacham. "With neither side willing to concede much over the near-term, while the headline risk is likely to intensify, we continue to anticipate little major, structural changes over the near term, while there could be movement on smaller, incremental drug pricing proposals this year."

A Contrarian Indicator

Contrarian indicators aren't always guaranteed avenues, but there are times when they can be useful. With biotech funds, including IBB, this may be one of those times.

Through the end of September, biotech funds suffered seven straight weeks of outflows, while IBB lost almost $262 million in assets over the third quarter. The fourth quarter is still in its early innings, but IBB has already shed almost $97 million.

These departures are happening just as IBB is perking up, and that could be a sign some market participants are throwing in the biotech towel at the wrong time.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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