Have I Got a Biotech Stock For You!!!

I spent a lot of time in Romania during the early 2000’s, helping companies privatize. There was a ton of opportunity to acquire older, cash flowing, businesses at reasonable valuations. However, most locals weren’t so interested in this…instead, the nearly universal comment we got from company owners was, “this company is okay, but let me tell you about this real estate deal I have!”

They say one of the key markers for a bubble in stocks is when cabbies (now Uber drivers?) share their latest trades with you. In Romania around 2005 prices in Bucharest rivaled Park Avenue and everyone had a property you should look at. Trust me on this, prices in Bucharest should never compare with NY, and they don’t anymore.

When the herd is moving in one direction, it pays to step outside the pack and ask yourself is this a bubble. Over the last few weeks I’ve asked many investors to share their best ideas with me. Universally, the response I get is a micro-cap biotech stock. Which has led me to ask the question of whether or not this is a good time to be looking at small and micro-cap biotech. I don’t believe it is.

Fundamentals are rather mixed…
There is certainly a lot to be optimistic about in healthcare, biotech in particular. The successes in medicine are coming rapidly as new therapies like CAR-T and regenerative medicine make dramatic strides.

However, these positive achievements have moved from speculative excitement in the stocks, to expectations of success. Check out Bluebird, off its highs, but still up over 250% in the last year…

Or, look at NKTR…up around 400%

Which is not to say that these aren’t great companies with lots of positive things going on. They might both go higher, I don’t have an opinion on them. But, success stories such as these have brought more investors into small cap biotech in droves, sending valuations to very high levels.

At the same time, we are coming towards a mid-term election. This election is coming at a time when the government has failed to do anything to slow down the increase in healthcare costs. Instead, on the back of the failed efforts to reform Obamacare, we are looking at yet another year of large increases in insurance premiums.

I would expect to see healthcare costs become a major topic leading into the next election. With drug prices the most obvious victim of negative publicity from politicians. Wil there be substantial changes as a result of this? Probably not. Will shares of companies creating drugs suffer? It’s quite likely.

The leaders are breaking down…
Looking at the large cap biotechs, they are starting to reflect fatigue from the rally and concern over the future. The IBB is the index most watched for this industry and this chart really scares me.

Divergence between large and small…
While the large cap biotechs are looking weaker, what’s happening with the smaller caps? The optimism that has led to the strong rally seems to be lasting longer in this group. Historically, the shares trade together, but we are seeing a major divergence in the last few months.

The ALPS (a smaller cap biotech ETF) tracked very closely with the IBB up until late in the fall. Since then, it has done much better. Obviously, the concerns that are hitting larger caps is not yet infecting the smaller companies.

Looking at a longer term chart (ALPS has been around for about 3 years), they tend to trade in sync most of the time. However, there was a significant divergence once before. When biotech shares retreated in the summer of 2015, and again later in the fall, it was foretold by a small cap spike that was not confirmed by the larger leaders.

Fade the herd…
In Romania in 2005, everyone knew that the real estate market was going higher. With the money flowing into the country, the joining of the EU, the opportunities to restructure cold war decimated businesses, it was inevitable. Until it wasn’t…today, property in Bucharest trades at a fraction of Park Avenue, an appropriate level.

When everyone tells me that their favorite investment idea is a micro-cap biotech, my radar sends off warnings. The fundamentals here are strong on the surface. Yet, the market is a balancing act of fear and greed. There appears to be very little of the former and a lot of the latter here. I say, buyer beware.

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  1. As usual, I did enjoy your articles. I am still stuck with good old DXD. But I invested also in another company : Imagination Park ( Ticker IP )
    If you have some time, please, can you let me know what you think of this company.
    I wish you all the best,

    Luc Janssens

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