Biotech Is Officially in a Bear Market. Is It Time to Panic?

The SPDR S&P Biotech ETF is down 27% in just the past six weeks placing it squarely in bear market territory. Is it time for investors to duck and cover?

Apr 12, 2014 at 4:03PM

There was once a time when the biotech sector could do no wrong. Venture capital was literally coming up out of the floor to invest in the latest new development platforms. Secondary offerings were also being met with plenty of buyers. And let's not forget that IPOs were lined up at the gates just waiting for their chance to go public on the Nasdaq or NYSE. Best of all, optimists were making bank with the SPDR S&P Biotech ETF (NYSEMKT:XBI) up nearly 300% since its recession lows.

But that was six weeks ago.

Bubble Burst

Source: Urbanicsgroup, Flickr.

The new biotech reality is actually quite grim. Shares of the SPDR S&P Biotech ETF, which currently has 84 different companies in the fund, are officially in bear market territory after dropping 27% in just the past six weeks! The selling has really accelerated over the past three weeks leaving biotech investors to wonder whether or not now is the time panic and sell everything.

The answer to that question really depends on what your investment time horizon is and what you've been buying within the biotech space.

Over the past couple of weeks I've looked at a number of reasons why the biotech rally may be coming to a close. Last month I opined that three factors -- frothy post-IPO valuation, acquisitions that were a reach on a price-basis, and investors counting their chickens before their hatched with wholly clinical-stage pipelines -- could ultimately send the biotech sector lower. It appears that many of these are finally coming to fruition.

Day-traders and speculators: beware
What this means is that traders with short time horizons, or considerably more speculative investors who are purchasing wholly clinical-stage pipelines, could encounter more volatility and more potential downside if the biotech sector continues to hiccup.

Take Intercept Pharmaceuticals (NASDAQ:ICPT) as an example. Not to take anything away from its nonalcoholic steatohepatitis experimental drug obeticholic acid which was stopped early in a phase 2 study, but we don't even have the complete data on this trial yet. Yes, the therapy met its primary endpoint with statistically significant results, but there are also visible questions about the safety of OCA for long-term use. With no FDA-approved drugs on the market and a current value of $5.2 billion this is the type of company whose investors could be in for a wild ride.

If, however, your plan is to hold biopharmaceuticals that are established, profitable, and/or have quality pipelines for a lengthier period of time, then this biotech swoon isn't an opportunity to panic. Instead, it could be the opportunity you've been waiting for to go shopping.

Buy established companies
Simply speaking, established companies have existing products already on the market and they often have a robust pipeline as well. They're the type of company you buy and hold without losing sleep each night. One that readily comes to mind is Swiss-based Roche (NASDAQOTH:RHHBY).

Roche is an oncology giant with such blockbusters are breast cancer drug Herceptin, lung and brain cancer drug Avastin, and rheumatoid arthritis/cancer drug Mabthera/Rituxan. However, Roche also has therapies in a number of other settings including neuroscience, virology, respiratory diseases, ophthalmology, and cardiovascular diseases, just to name a few.

Source: Roche. 

This product diversity gives it many different avenues of growth should one of its segments suffer a setback. Were that not enough, Roche also has more than 100 clinical studies ongoing at the moment, which doesn't even count what it has going on in the preclinical setting as well. Tack on an annual dividend that's often around a 2% yield and you can see why I believe Roche could easily help you weather the biotech bear market.

Buy profitable companies
If you prefer a little more risk in your diet but don't want to deal with the expectation of quarterly loss after quarterly loss, an easy way to avoid the biotech doldrums is to pick out highly profitable companies. Although Gilead Sciences (NASDAQ:GILD) has taken it on the chin like its peers in recent weeks, I believe it represents a shining example of a high-growth profitable company to consider.

2013 Annual Report, Source: Gilead Sciences. 

Gilead has a number of key catalysts it's working with, including the recent approval of Sovaldi, the first oral Hepatitis C medication that in select genotypes can be administered without interferon (interferon is known to cause flu-like symptoms in patients). In addition, Gilead also has Stribild, its four-in-one completely in-house HIV-1 prevention medicine designed for treatment-naïve patients. In the past with HIV therapies such as Atripla Gilead has had to split its revenue stream with other biopharmaceutical companies, but this completely in-house pill gives it an opportunity to dominate the market, pad its margins, and provide hope to HIV patients that their disease progression will slow or possibly even stop.

Gilead is very profitable with Wall Street projecting about $9 billion in profits by fiscal 2015 with a revenue growth rate over the next five years of an eye-popping 33%. If the biotech sector continues to sink, Gilead is the type of company you could lean on.

Buy diverse pipelines
Lastly, even though it's been battered over the past month, a diverse pipeline such as Isis Pharmaceuticals (NASDAQ:IONS) could give investors multiple chances to hit a home run.

At the moment Isis only has one FDA-approved therapy, Kynamro, which was brought to market in collaboration with Sanofi. Clearly Kynamro alone isn't enough to push Isis to a nearly $4 billion valuation given that losses are expected to continue for the near future.

However, the fact that Isis has 34 clinical and preclinical studies ongoing with approximately one dozen different collaborative partners certainly puts into perspective the optimism behind Isis. You've often heard me make the baseball analogy that each study is the equivalent of a pitch and the company is the batter that's swinging for the fences. More pitches equate to more chances for a company to hit a home run. Isis, in this case, has the potential to be quite "the slugger," and it's for that reason investors may want to consider adding its bountiful pipeline to their portfolio.

Even if the biotech sector rebounds with a vengeance few stocks will likely have the potential to keep up with this top stock in 2014
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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool recommends Gilead Sciences and Isis Pharmaceuticals.. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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