Halloween only comes once a year, but for investors, the entire month of October was frightful. The S&P 500 index tumbled nearly 10% from the end of September to its low on Oct. 29, and the returns in biotech were even more dreadful, with the iShares Nasdaq Biotechnology ETF (IBB 0.49%) losing about 15% of its value at one point. Drops like that can test the nerves of even the most levelheaded investor, so in this episode of The Motley Fool's Industry Focus: Healthcare, host Shannon Jones is joined by Motley Fool contributor Todd Campbell to put these grizzly events in perspective and offer up insight into lessons investors can learn from some of this year's scariest biotech stocks.

In this episode, Jones and Campbell discuss:

  • Why 10% corrections shouldn't cause you to panic.
  • What Geron Corporation's (GERN 3.31%) terrifying tumble teaches us about binary risk.
  • How Synergy Pharmaceuticals' (NASDAQ: SGYP) shocking disclosure is a reminder to look behind the curtain at a company's financials.
  • Why Incyte Corporation's (INCY 0.84%) horrific trial results were disheartening.
  • Tips to surviving the next market tumble.

A full transcript follows the video.

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This video was recorded on Oct. 31, 2018.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today is Wednesday, October 31st, and we're talking Healthcare. I'm your host, Shannon Jones. I'm joined via Skype by specialist Todd Campbell. Todd, I'm super excited, because first of all, today is Halloween, and second of all, we're doing a Halloween-themed episode focused on Halloween horror -- specifically, we're talking scary markets, scary stocks, and how to best keep your fears in check during this spooky time. Todd, as I understand it, when it comes to Halloween, the Campbell household goes all-out. Am I right?

Todd Campbell: We do. Oh no, I just lost my prop! I had my wig on and everything. Our listeners won't be able to see it. They'll have to go online to Twitter or something, I posted it there. People can see my mad scientist outfit this year.

Jones: Yeah, please check out Todd's costume on Twitter. Todd, you're @EBCapital, right?

Campbell: Yeah. I think people will get a kick out of it. You have to have a little bit of fun, right?!

Jones: [laughs] That's right. Todd, I think in this day and time, we really do need fun, because when it comes to scary, nothing is scarier than the markets right now, especially over the month of October, the spookiest month of the year. I actually read one headline this morning, among many that were, of course, fear-mongering. It basically said the S&P 500 is set to finish October with its worst month since the 2008-2009 financial crisis, and it's not alone. Many of the other major indices are also down, too. Todd, the uncertainty and fear in the markets right now is certainly reaching new heights. Should we all be afraid?

Campbell: All that howling we heard last month wasn't werewolves, was it? It was people checking their account balance, groaning in agony, watching what was happening. I think it's very important during these scary times -- to get real for a second. I'll even take off my wig, [laughs] so people can really see I'm getting serious. Corrections like this are pretty common. Yardeni, which is a research firm that's been around since I've been in the business, since the late 90s at least -- they keep track of this stuff. There's been seven drops of 9% or more just since 2010. We got down, about 9.4% on the month at one point. These are not that uncommon. There's been 11 drops of greater than 5% or more since 2010. And yet, as scary as those were, because you had individual stocks -- especially if you're a growth investor -- get walloped a heck of a lot more than that. You had names like bluebird bio that fell 28% in the month. You had the IBB, the biotech ETF that I like to follow, that was down 15%.

So, yeah, these are painful in the moment, but recognize that despite all of these that we've had in the past, just since 2010, the market has recovered and gone on to make new highs. The wrong choice -- or the scariest choice -- the one that would leave you groaning much longer into the future, would be to react to those moments and sell, and not to have been able to participate when those stocks rallied back. Shannon, I guarantee, if you sell during those moments, you are not going to time the bottom perfectly. You are not going to get back in and ride that higher.

Jones: Todd, to your point, where we are at in this particular market cycle, it's nothing new. More importantly, there's not any one thing really driving this slowdown across the stock market. You've got U.S.-China trade war concerns. We're in a rising rate environment. Particularly in China, you've got heavy selling for a lot of Chinese stocks as their economy continues to slow down. And then, of course, as everyone knows, we are approaching election season. There's a lot of political rhetoric going around right now, especially as it relates to drug pricing, too. So, you're seeing that play out across the sector.

To your point, and going back to what you said, the key is not to be afraid, not to sell your stocks. If anything, consider this an opportunity to really double down on some of those really impressive stocks that have good management are continuing to drive both top and bottom line growth, and figuring out how you can buy a lot of these stocks at a discount.

Campbell: I agree with that. I've been watching the markets very closely through the internet boom and bust and through the great recession and through where we are today. That kind of long-haul strategy is what can allow you to sleep at night. I'm sure we'll talk later on down the show, not every stock deserves to be held forever in a portfolio, but the market certainly has proven time and time again that if you're willing to ride it out for a decade or more, the odds tilt significantly in your favor for turning a profit. I've seen statistics that say in any rolling 20-year period, you've never lost money. So, I think you have to have that long, calm view. Spend less time listening to the talking heads on TV who are shouting and pressing buttons and making all sorts of crazy noises. Other than, obviously, on Halloween. We're allowed to do that, right? 

Jones: [laughs] No names shall be given there, Todd. We'll dive into more of how to frame your mind in a cycle such as the one that we're in when it comes to your portfolio. 

But first, before we even dig into that, Todd, we're actually going to transition. We've been talking about the market. Let's actually dig into some of the scariest healthcare stocks that we've seen so far this year.

Shifting gears, let's talk about some spooky stocks. Of course, as many of our listeners can attest, in the healthcare space, there's never a shortage of spooky, scary stocks to follow along with. Certainly, this year has not been an exception to that rule. There are plenty of management mishaps, some commercialization woes, pipeline blow-ups. We've chosen what we consider to be the top three spookiest stocks of this year. 

I want to start off with the first one. I like to call this one the zombie stock. That company is called Geron Corporation, ticker GERN. Todd, this company has been around for almost 30 years, believe it or not. It's really been hoping to drag its lifeless zombie body across the finish line, getting from small biotech to commercially profitable biotech, and it has really been limping its way to that.

I was looking today at the stock. It had its heyday back in the early 2000s. At one point, the stock was actually trading over $60 a share. Today, that share price is $1.53, believe it or not. Todd, I'm starting to think that maybe this might be the end of the road for Geron. What do you think?

Campbell: It does not look good. This is a super scary stock. It has to be one of the most frustrating stocks for investors who had a lot of high hopes that Imetelstat, their drug for myelofibrosis, myelodysplastic syndrome, would pan out. Unfortunately, they were developing that drug with Johnson & Johnson. Johnson & Johnson had an opt-out clause in their license agreement that would allow them to give their rights back to Geron if they didn't like what they saw in the Phase II data. And sure enough, that's what happened. J&J crunched the numbers, looked at it, looked at the developing competitive landscape in the indications and decided, "Yep, we're not willing to hand over all of these hundreds of millions of dollars in milestones, pay for all of these development costs, to be able to get this Imetelstat across the finish line."

Now, that leaves Geron in a really tight spot. They need to figure out, "We just lost our licensing partner. We don't have a ton of cash on the books. And now, we're going to have to conduct these expensive Phase III trials on our own. How the heck are we going to do that?" That's obviously the big reason why this has been one of the worst stock performers this year. And sadly, Shannon, I don't think there's a lot of hope left for a reawakening of this stock, at least until 2020, when maybe, maybe, if they can find the cash somewhere to keep going, they might have some additional data they can share with us that gets investors excited. 

Jones: What's so disappointing about this stock is, there was tremendous optimism heading into many of these trials. In myelofibrosis that you mentioned, the early data really seemed to suggest that the drug could actually reverse the effects of myelofibrosis, which is basically a type of cancer that turns the bone marrow into scar tissue. There was a lot of optimism with that. And it certainly would have given Geron's Imetelstat drug a leg up commercially when you compare it to Incyte's Jakafi. Jakafi does not do that, and JAK inhibitors don't do that. So, this could have been a really interesting play, could have easily been a frontrunner in that space. Even on the other indication, MDS, myelodysplastic syndrome, a cancer-like disease of the bone marrow, results were also encouraging there, initially. Patients treated with the drug at one point actually became blood transfusion-free. They didn't have to continuously go for blood transfusions. But over time, you actually started to see these patients relapse. That meant basically that the treatment didn't have that durable effect that they were hoping there. On both fronts, very disappointing. We know that for MDS, they are going to proceed with Phase III. A lot of hope lost, though, I think, for myelofibrosis. A lot of big question marks there. But they were a lot of red flags along the way, too, Todd. 

Campbell: Yeah. Creaky doors, dark hallways, voices telling you maybe you should leave the building. [laughs] "Why are you going into this dark room?" If we can take away any lessons that we can apply to our future investments in biotech, it would be to always be a little bit cautious when you've got, for lack of a better term, a one trick pony, one drug in development. 90% of clinical trials fail. The odds are set against you. 

I would also say that another one of the warning signs to learn from was the fact that J&J had to discard, early on, a low dose version of Imetelstat or one of the low-dose cohorts because of a lack of efficacy. Maybe that was hinting that there could be some problems beyond that.

And the last warning side might have been the fact that J&J really didn't risk a lot to license this drug. They only paid $35 million upfront. It was all back end, loaded with milestones after they would have had agreed to take this thing into Phase III. So, maybe avoid small, upfront, back end loaded deals.

Jones: Very important lessons there. Even, there was some writing on the wall when you saw the company raise about $84 million in the second quarter of this year. A lot of investors were already beginning to suspect that J&J wasn't going to move forward because Geron was actually set to receive $65 million in a milestone payment. Of course, all of that was dependent on whether or not they would proceed. So, I think the writing was on the wall when you saw the company do that financing round earlier this year.

I think the take-home message, it's certainly troubling, frightening for Geron investors, but even more so for the patients. Todd, as you know, Jakafi is the lone winner out there, but it doesn't work for everyone, and it doesn't work all that well for very long.

Campbell: 75% discontinuation rate for Jakafi within five years. A major and important need for new drug therapies. Geron's derailing of its drug is bad news and disappointing for patients who are eager to find new options. 

Jones: Exactly. I think the company ended with about $183 million in cash on its books. It's obviously going to need to either find a new partner and get some money or continue to try to raise funds. I think it's going to be really hard based on where they're at and what the data is showing currently. Certainly something to keep your eye on, if Geron can continue for maybe another 30 years. I don't think so, but certainly something to watch.

Our next stock, Todd, this is a stock called Synergy Pharmaceuticals, ticker SGYP. This is a biopharma stock that has had its eyes set on the very highly lucrative and very competitive gastrointestinal space. It has its lead drug, Trulance, that was actually approved in two GI indications going back to early 2017. They got approved for their second indication earlier this year. I took a look at this stock. Right now, the stock is sitting at about, believe it or not, $0.39 a share. That's down 85% on the year. 

Todd, this stock is another classic example of where marketing approval is really only the beginning. Commercialization is a much larger, much bigger beast that's much tougher to conquer.

Campbell: Absolutely. Clinical stage stocks, they'll rally up, they'll rally down, they'll trade a lot on excitement and peak sales forecasts and all that stuff. Then, when it gets to rubber meets the road and you actually have to prove that out by winning over payers and getting in front of doctors, it's a very different ballgame. A lot of companies struggle to do it, and that's why they go out and get licensing partners. Trulance competes against Ironwood's Linzess. Ironwood is paired up on that drug with Allergan, which is a huge company with plenty of deep pockets that can market the drug and get it in front of people and swing a big stick when it's talking to different payers to get formulary coverage that is better than what Synergy could do with Trulance.

The scary thing here for investors really is the disclosure recently that Synergy is having a very difficult time in refinancing its debt. That has increased the risk that this company's operating expenses are just so high that it's going to burn through the remaining cash that it has. And if it can't renegotiate, then it could be called into default, because currently, it doesn't meet the covenants on the debt that it owes. Of course, that would be bad news for shareholders and the employees of the company and for patients, because they'd lose, potentially, access to what could very well be a fine drug that would work very well for them.

Jones: I think, between the go-it-alone strategy... I know back in 2015, the company was attempting to find a partner, potentially even a buyer. According to the company, there weren't any offers that they thought met the value of what Trulance was offering and for the value of the company. There was no buyer, no partnership. You mentioned the other issue, and that's related to these loan agreements. You've got sales and liquidity covenants that the company is currently not meeting, which puts it in a particularly dire place. There was the business update that they provided recently. Honestly, that was one of the saddest, most depressing business updates I think I've ever read. Ultimately it came down to, "We are very close and on the verge of bankruptcy." That's what I got from that. 

Another thing I want to go back to is, you mentioned with Linzess and Ironwood and Allergan, this is a very competitive space. You've got very deep-pocketed competitors who have a very strong commercial sales force. And now, you're attempting to come onto the market alone. You don't have a deep-pocketed partner that can really help offset some of these costs and get you across the finish line. What you see happening with Synergy is a classic tale of, for these small biotechs, you have to have a big partner, especially in competitive spaces like GI.

Campbell: Yeah. Again, to lessons learned or the warning signs, what were those creaking doors? What were those voices saying to us that maybe would have helped us to avoid investing in Synergy? I think the things to bear in mind are, rapid cash burn. How quickly are operating expenses and R&D drawing down the cash that you have on your balance sheet? How often are these companies going out and having to tap investors for dilutive equity? And if they're not able to do that, do they owe money through loans to other third parties that aren't your traditional banks that are providing liquidity? Are they converts? Are they preferreds? Do they have interest rates that are, in the case of Synergy, 9.5%? Obviously, lenders were not very willing to front up favorable rates, money to this company. Maybe that's a warning sign. Just pay attention, listeners, to how much debt companies have on the balance sheet, how much cash they have, how quickly they're going through that cash, and where they're getting the funding that they need to keep going.

Jones: Fair enough. Todd, I'm going to throw out another warning sign. You tell me if you think this is a warning sign. This was actually the company that was behind the infamous Poop Troop. Excuse my language, I'm not making that up. This is literally the marketing ploy the company went after in 2017. They created this pack of emojis designed to increase the conversations around constipation. Weirdest, strangest thing I think I've ever seen, Todd. Was that a warning sign in your eyes? [laughs] 

Campbell: [laughs] Could be! I mean, someone took a swing, and unfortunately, it missed in the marketing department on that one. 

Jones: For sure. Certainly not enough to keep this stock out of the toilet. Yes, I did go there. 

Let's turn our attention to our third and final stock. Todd, this one, for me, there was so much writing on this stock. The company is Incyte, ticker INCY. It's not so much the stock that's scary, it's what happened earlier this year with a drug that literally every investor had been watching, especially those that have been following the cancer immunotherapy space. 

They had their lead drug, Epacadostat. Essentially, what they were attempting to do is to see if they could take this drug and combine it with big players like Merck's Keytruda or Bristol Myers Squibb and Opdivo, and combine these drugs to have the combination effect of added efficacy by joining these drugs together. But what we saw in the trials was, that wasn't exactly the case, and things just started to fall apart. Todd, what can you tell us about that? 

Campbell: I think the IDO inhibitor should have been called Uh-Oh. [laughs] 

Jones: [laughs] Fair enough!

Campbell: Yeah, there was a ton of excitement leading up to the trial results that came out earlier this year that IDO inhibition could be done alongside of some of these other immuno checkpoint therapies that had been so successful in oncology. That's the PD1s and PDL1s that we've talked about on the show in the past. Matching these two up with slightly different mechanisms of action to be able to allow the immune system to go out, find these cancer cells, and destroy them. And there was some early data that looked really, really encouraging. As a matter of fact, it was so encouraging, Shannon, that Incyte basically jumped the shark. They went out and started up a ton of late-stage trials combining their drug with Keytruda, which is Merck's PD1, to see whether or not they could reshape how we treat various cancers. They went into the bad news with ... I had it written down earlier, I think it was something like eight different late stage, registration-ready studies. And exiting the trial, where it came up short, it just didn't work. It didn't work in metastatic melanoma. They ended up having to ratchet back that program almost entirely. I think they still have a couple lung cancer trials that are going on in combination with Keytruda. But they even downgraded those from registration studies to Phase II mid-stage studies.

Really bad news all around for patients and investors who were excited about the IDO space. And shockwaves, too, that cut across to different companies. Bristol Myers abandoned their IDO program after the news was reported. There was another company, NewLink, who was working on IDO inhibitors. They're trading at like $2 a share now. At one point, they were a $50 stock. 

Jones: I think it was actually 18 IDO combo trials going on at the time. Incyte's IDO inhibitor was the furthest along, so the readthrough to the industry was just tremendous. There was so much hope going into the space. As a matter of fact, Epacadostat was at one point #3 on EvaluatePharma's top 10 list of 2018 launches, with projected close to $2 billion in peak sales. There was a lot riding on this. 

With that being said, though, of the three stocks, I think Incyte was probably best-prepared to have these setbacks. As you know, being a biopharma investor, no matter how encouraging early stage data looks, oftentimes, when you get to these bigger trials, things just don't work out. But Incyte has, thankfully, approved products that are blockbusters and can lessen the blow of what happened with this drug.

Campbell: I think, out of the three companies we just talked about, this one is most likely best positioned to bounce back and regain some of that ground. It does have a pipeline, it does have products on the market right now, including the blockbuster Jakafi. So, it can withstand that hit. It's disappointing, though. Obviously, having your shares cut in half in the span of a few months is never something that investors want to see. We'll have to see where we go from here with this company. There is some competition coming from Celgene and Fedratinib, potentially, as soon as late next year. We're going to want to keep an eye on that, as well. 

Jones: For sure. Turning our attention, we've talked about the market, we've talked about certain stocks that we've been watching. But in terms of the average everyday investor, when it comes to protecting yourself, preparing for not only bad news, but also corrections within the market, what are some general words of wisdom when it comes to portfolios?

Campbell: Ignore a lot of what you hear. [laughs] I have to say it. Just back up a little bit. We saw this nearly 10% decline in the market this month. Over the course of a month, OK, if I lose a percent here or there, that's not such a horrible feeling. But we had two separate days this past month where the S&P 500 fell more than 3% in the trading session. I guarantee you that we have listeners out there who saw their accounts fall by multiples of that, because some of these stocks were falling 5-10% on those days. That's hard. It's hard, as an investor, to watch and see that, and not want to do something. Right, Shannon? We are hard-wired to avoid danger. It doesn't matter if that danger is a ghoul coming up behind us that we can't see, the creepy music sounding, or if it's coming in a falling account balance. We need to fight back, and a way we can fight back against those emotions and those reactions is to be very proactive. Recognize that 3% declines, yeah, it's bad, but they're not uncommon. They happen. Most of the time, the stock market is actually trading higher. If you had gone out and bought the 3% dip, you would oftentimes come out ahead within 30 days. If you look just since 2000, you've seen the S&P 500 drop at least 3% 66 times. 66 single-day drops of 3% or more. Undeniably, each one of those felt absolutely horrible. Right, Shannon?

Jones: It was painful, to say the least. And one thing I want to bring out is, especially if you're a healthcare investor, it's important to diversify. That helps at least lessen the pain and the blow long-term. I will say, though, that even if the market were to go into true correction territory -- maybe a recession, even -- the healthcare industry is one of those sectors that, generally, I don't like the term "recession-proof." I don't really think anything is. But, in terms of performance, if you think about it, when it comes to medications, when it comes to surgeries, even, this is one of the sectors where people will tend to continue to spend money. You need your medications. If you're sick, you need to go to the doctor. If you're really sick, you may need to have surgery. There are definitely some defensive plays that you can go after. There are stocks like Johnson & Johnson, a huge dividend aristocrat stock that's got a very diversified revenue base. It has the consumer goods, it has a quite impressive immune oncology branch to it, as well. Another one is Intuitive Surgical. That's probably one of The Fool's top stocks. Intuitive Surgical is focused on robotic surgery, and really led the way with robotic surgery. There are a number of different ways that you can start to diversify the risk across the healthcare space. And really, even more so, your portfolio shouldn't just be made of all healthcare stocks, either.

Campbell: Right. Diversify, diversify, diversify. See? I said it. I'm going to try to do an episode where I don't. I said it again. I would also add to that list, Shannon, don't use margin. Margin cuts both ways. We saw plenty of people, I'm sure, last month who ended up getting forced out of stocks because of margin calls, and forced selling by their brokers. Just don't do margin. Diversify. Don't use margin. Keep a little bit of dry powder, a little bit of cash on the sidelines. It doesn't have to be a lot. Even if it's only 5% of the portfolio, that will allow you to take advantage of these drops. When a name like Intuitive Surgical goes on sale, or Illumina, or some of these other great companies that we talk about on the show, when those go on sale, you're able to step in and at least deploy some of that money on those 3% down days. 

To go back to that one more time, to hammer this point home, there have been 18 one-day drops of at least 3% just since 2010. And 12 of the 16 leading up to the two that happened this month, the market was higher 30 days later. So, don't react in the moment to those down 3% days. Have a watchlist. Have some top stocks ready, a little cash on the side to be able to buy and take advantage of it. It's an opportunity. 

Jones: Awesome. As always, wise, wise words from Todd Campbell himself. I want to thank all of our listeners for tuning in. That's it for this week's show, but certainly check us out next week. In the meantime, be sure to check out Todd Campbell's costume on Twitter, please. It's awesome. He goes all out. 

As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Steve Broido. For Todd Campbell, 'm Shannon Jones. Thanks for listening and Fool on!