Impending rate cuts, attractive valuations and a wave of catalysts are setting up biotech stocks for outperformance in the quarters to come.
This is the view of Janus Henderson’s Andy Acker and Dan Lyons, portfolio managers on asset manager’s healthcare and biotech teams.
Biotech stocks have been out of favour for the past few years after interest rate hikes battered the sector’s valuations and dried up funding activity.
The S&P Biotechnology Select Industry Index has yet to recover its highs of 2021.
In late 2023, biotechnology stocks experienced a brief surge as investors bet the Federal Reserve would start to trim rates in early 2024.
But that enthusiasm waned when higher-than-expected inflation prints in the early months of the year caused the central bank to hold off cutting rates.
With inflation now trending consistently lower and interest rate cuts from the Federal Reserve finally in sight, Acker and Lyons believe it should prove to be a tailwind for the biotech sector.
They noted that since the US Consumer Price Index fell to an annual rate of 3% in mid-July, biotech stocks have outperformed the broader equity market.
“This divergence in returns has precedence,” they said. “In seven of the last eight rate-cutting cycles, the biotech sector has delivered gains both one month and six months after the first rate drop.”
“After 12 months, the sector had outperformed the S&P 500 by an average of 16%.”
Attractive valuations and accelerating innovation
The managers also argue that low valuations and growing investor enthusiasm will give biotech stocks “ample room to run”.
“Biotechnology valuations have been depressed as a result of a three-year pullback that ended in late 2023,” they said.
“As such, as of mid-July, nearly 130 biotech companies had a negative enterprise value — meaning companies were priced as though any research and development (R&D) would only detract from a firm’s value, not add to it.”
“While that figure is down from a peak of 232 last year, it is still well above pre-downturn levels.”
They also have observed more positive reactions from the market on good news within the sector: in the second quarter of 2024 the average biotech stock returned 44% following a positive news event, up from 31% during the same quarter the year before.
When it comes to sector fundamentals, the managers said they “expect no shortage of potential catalysts” for biotech stocks in the months ahead.
“In the first half of 2024, the Food and Drug Administration approved more than two dozen new drugs, including Imdelltra, a targeted bispecific T-cell engager (TCE) from Amgen for patients with an advanced form of small cell lung cancer,” they said.
“Another 41 drugs are expected to be reviewed by the end of the year, including for cancer, schizophrenia, and liver disease, and some could have blockbuster potential (annual sales of $1bn or more).”
“This innovation — much of it driven by the sector’s small- and mid-cap companies — is helping fuel a wave of mergers and acquisitions.”
Indeed, during the first half of 2024, 21 biotech transactions have been announced, outpacing or equal to total deals done in seven of the last nine years.
As the US election result and its regulatory impact becomes more clear later in the year, the portfolio managers believe deal sizes could increase.
They also note that companies are finding it easier to raise capital to fund R&D, with $28bn raised so far in 2024.
“In our view, these trends indicate demand for biotech’s innovation is alive and well,” they said.
“We also think they suggest it’s only a matter of time — and a few macro factors such as rate cuts and the U.S. election getting sorted out — before biotech could once again come out on top.”
