Why I’m getting more bullish on biotech

Wen Shi, PhD, CFA, Global Industry Analyst
2022-06-30
Archived info
Archived pieces remain available on the site. Please consider the publish date while reading these older pieces.

The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.

The biotechnology sector, especially SMID-cap biotech equities, suffered a dramatic drawdown in 2021. Investor sentiment toward the sector remains poor, but my outlook has become increasingly bullish as multiple headwinds facing biotech over the past year or so begin to abate and turn into potential tailwinds for 2022 and beyond. Encouragingly, the level of innovation across the industry has never been higher, in my view. I believe many biotech stocks may be nearing a bottom, even though the exact timing of (and catalyst for) a rebound remains unclear as of this writing.

A challenging 2021 for biotech sector

From its peak in early February 2021 through mid-February 2022, the SMID-cap biotech-dominated XBI Index was down 49%, lagging both the broader health care sector and the overall US equity market by sizable margins. The underperformance was deeper and lasted longer than any prior drawdown since the inception of the XBI Index in 2006. Bigger-cap biotech stocks also underperformed over the same trailing 12-month span, although not as severely as their SMID-cap counterparts.

A slew of challenges weighed on the biotech industry last year, including regulatory uncertainty, drug pricing worries, excessive numbers of new IPOs, a relative dearth of M&A deals, and generally frothy equity valuations. More recently, the widespread expectation of rising interest rates has loomed large as the US Federal Reserve (Fed) prepares to begin tightening monetary policy amid higher inflation.

Reasons for optimism going forward

However, I believe most of these headwinds are abating and (in some cases) even transitioning to tailwinds for 2022 and beyond, underpinning my bullish outlook for the industry.

  • FDA turmoil: The recent US Senate confirmation of Robert Califf as FDA commissioner was a positive development, in my opinion. I expect Dr. Califf to be a stabilizing force and a morale booster for the FDA staff, which has been under enormous strain due to the COVID-19 pandemic. In addition, reduced workloads related to COVID vaccines and therapeutics should enable FDA staff to focus more on non-COVID drug approvals and other priorities.
  • Drug pricing concerns: The worst-case scenario in US drug pricing reform entering 2021 — that sweeping legislation might lead to across-the-board, draconian price cuts — now appears to be off the table in the foreseeable future. Given the latest setbacks to the “Build Back Better” legislation, my base case is that no drug pricing reform will be enacted in 2022 (or even in 2023/2024). Another possibility is that some form of Medicare Part D benefit redesign and limited drug price negotiation could pass this year, from which the biotech industry as a whole would likely benefit.
  • Excessive numbers of IPOs: There were 82 biotech IPOs in 2021, compared with 69 in 2020 and 41 in 2019. Many of these companies were years away from the clinic and even further from generating derisking data or having drugs ready for regulatory review. In other words, many of these companies had no business going public. The good news: I expect to see a meaningful drop-off in the number of biotech IPOs this year. To wit, there have been only four so far, three of which are clinical-stage companies.
  • Relative dearth of M&A: Both the number and size of M&A deals transacted in 2021 were lower than in prior years, which may have been due to: 1) many sellers remaining wedded to unrealistically high valuation expectations from 2020; and 2) many buyers exercising greater caution around Federal Trade Commission (FTC) scrutiny. But sellers’ lofty expectations may be resetting in 2022, while many buyers are now flush with cash and may become more comfortable working within existing regulatory constraints. (That bears watching.)
  • Frothy equity valuations: Coming out of the initial “COVID dip” in March 2020, biotech valuations were bid up to historic highs later that year, as many generalist investors bought into innovative cures and treatments for various diseases. Then investor fund flows sharply reversed in 2021, moving from biotech and other COVID “winners” into COVID “losers” amid the reopening trade. Consequently, SMID-cap biotech valuations had corrected by roughly 50% as of early 2022, with several analyses suggesting they may now be close to bottoming.

Bottom line on biotech stocks

After a trying period over the past year or so, I believe now may be an opportune time for forward-thinking equity investors to take a fresh look at the biotech sector.

Expert

Related insights

Showing of Insights Posts
What does an equity market bottom look like? Continue reading
event
Quick Take
2022-11-30
Hidden corners of sustainability-related innovation Continue reading
event
Article
2023-06-30
Stock-based compensation and the tech sector Continue reading
event
Article
2023-07-31
Mid-2022 Asset Class Outlook Continue reading
event
Article
2023-07-31
2022 Equity Outlook Continue reading
event
2023-01-27

Read next