Biotech In A Bear Market. First Move? Don’t Panic!
It was a putrid week for biotech, partially triggered by a tweet from presidential candidate Hillary Clinton. The main biotech indices fell some 13% in five trading sessions. This sort of volatility is nothing new for this sector of the market. In fact, this is the fifth bear market for small cap biotech stocks since 2009. However, this too shall pass for this lucrative area of the market and brighter skies will return. Here are my time worn strategies for navigating the current turmoil in biotech. It doesn’t matter how one describes the action in the biotech sector this week, it was just plain ugly. The main biotech indices sold off ~13% including an almost five percent plunge on Friday even as the S&P 500 managed to end flat on the day. Investors in biotech have not been treated this much like rented mules by the market during one week in quite some time. (click to enlarge) Part of the deep pullback was triggered Monday by presidential candidate Hillary Clinton who tweeted her outrage about drug price “gouging” . She then made it part of her campaign as she tacks even further left for the upcoming primaries as a self-avowed socialist continues to gain against her in the polls for the contest for the Democratic Party nomination for president. It should be kept in mind that this type of electioneering is par for the course. Even if Mrs. Clinton is elected president and wanted to follow through on these primary promises, they have absolutely little to no chance of passing. The Republicans will still be charge of the House of Representatives and quite possibly the Senate. There are also no guarantees that Mrs. Clinton will be elected president or even secure the Democratic nomination for that matter. Who knows either her and/or Republican front runner Donald Trump might even develop a sense of shame at some point and withdraw from the race. In addition, this sort of turmoil is nothing new to this lucrative but volatile sector of the market. This is now the fifth time since 2009 that the small cap biotech sector has declined by at least 20% and entered an official bear market. The last time started in early March of last year. During that decline that lasted 6-8 weeks, large cap growth names in the sector like Gilead Sciences (NASDAQ: GILD ) fell back 20% to 30% before bottoming. Many small cap names plunged 50% to 70% before all was said and done. Given that I run the Biotech Forum on SeekingAlpha and approximately 40% of my articles here, on Real Money Pro and Investors Alley are centered on biotech investing; I have been inundated from questions from readers and subscribers this week. The quick downturn has caused a significant amount of anxiety. This is understandable but also part of investing in the biotech industry. I have been warning since the early summer that the overall market was overdue for at least a 10% pull back and that the biotech sector was quite possibly in a bubble as well. The weakness in the market should be no surprise and is also affecting other high beta sectors of equities with small cap stocks being down 3.6% this week as well. My first piece of advice is the same as the core theme of the cult classic “The Hitchhiker’s Guide to the Galaxy”. This is simply “Don’t Panic!”. This too shall pass. Thanks to algorithmic computerized generated trading now accounting for more than 50% of trading in the equity markets; these declines are getting deeper and quicker than they used to be as these programs decide to abandon momentum driven and high beta sectors of the market in nano-seconds. I have been successfully investing in biotech for over two decades. I have seen many such bouts of turmoil and I plan to see many, many more before I hang up my investing spurs. Over these periods I have developed several core principles to manage a well-diversified biotech portfolio that helps position these holdings to outperform the overall market over time while to help mitigate risk and lessen the overall volatility of the portfolio as well. My hope is that they can help readers manage through the current carnage in the biotech sector until sentiment once again turns positive on this part of the market. April 14th Article on Biotech Forum: The biotech & biopharma space is one of the most volatile of any of the sectors of the market. This is especially true as it relates to the small caps that make up a good portion of the companies that occupied the biotech & biopharma arena. It is not unusual to see a small biotech equity be listed as the top gainer of the day in the market with another small play in the space taking biggest loser of the day honors. Volatility is a fact of life for investors who want to invest in these high beta sectors of the markets. One does so because few if any areas of the market can offer up the five and ten baggers that are the stuff of dreams and can turbocharged the performance of one’s portfolio by just be fortunate enough to occasionally catch one of these “rockets”. Over the years I have identified many of these huge winners in the pages of SeekingAlpha including Lannett Group (LCI ), ZELTIQ Aesthetics (NASDAQ: ZLTQ ), Novavax (NASDAQ: NVAX ) , Avanir Pharmaceuticals (NASDAQ: AVNR ) and myriad others. Recently Eagle Pharmaceuticals (NASDAQ: EGRX ) has soared over 275% since I listed as a “Best Idea” on Real Money Pro on 12/19/2014. (click to enlarge) (click to enlarge) I have also had my share of disappointments like Regado Biosciences (RGDO) and Synta Pharmaceuticals (NASDAQ: SNTA ). It is simply the nature of the game. For every home run they will be at least one strike out. However, if managed right and optimized collection for small and large cap biotech & biopharma stocks can be a key contributor to overall outperformance from one’s portfolio over time. (click to enlarge) (click to enlarge) It is my passion and success in the biotech arena over the past two decades of investing that drove me to create the Biotech Forum which launched on SeekingAlpha early in April. I want to share my thoughts on how to properly manage and optimize a biotech/biopharma portfolio and some tricks of the trade have absorbed over many years of investing in this space. They will be the tenets of the Biotech Forum portfolio which will consist of twenty stocks. Five of these will be from the large cap space. These companies will already have achieve profitability, have solid products & pipelines and are selling at attractive or at least reasonable valuations on a long term investment basis. These will be labeled as “CORE” positions. The remaining 15 stocks will come from the more volatile and speculative small cap sector. These will be tagged with the “SPECULATIVE” moniker. Depending on your risk preferences you will want to weight each large cap selection three to six times heavier than each small cap pick. This will mean 50% to 75% of your portfolio will be made up of these more stable and less volatile large cap equities. The remaining portion of your portfolio we will go hunting for some multi-bag grand slams. This portfolio will be built slowly as I believe in dollar cost averaging in these areas. This sector has outperformed the overall market for five straight years and could be overdue for a pullback if sentiment sours on “risk on” areas of the market. Each month we will add one large cap pick and three small cap equities to the mix. Once we have our twenty stock portfolio we will make adjustments/modifications as we deem prudent over time. I will also offer up some future promising opportunities each month for those who might want to assemble a portfolio in a different or faster way than how we create the Biotech Forum portfolio. Our small cap selections will be focused on different technologies and disease areas to provide diversification. We will also look for concerns with multiple “shots on goal”, partnerships with larger players within the space, strong balance sheets which also could make attractive buyout opportunities. There are three terrible feelings when investing in small biotechs & biopharma stocks. The first is when a trial goes wrong or a company announces other disappointing news resulting in your investment cratering. Unfortunately, there is little one can do avoid these landmines as bringing a compound to market is a very complicated affair and is why one must make myriad small investments across promising opportunities in these sectors to provide diversification. The second thing that go wrong is when one makes an investment that comes at a very opportune time. Your stock doubles or triples in short order and you do not take any profits. Over time, the stock falls back to where you bought it or even lower and the feeling of regret of not taking any gains clouds future investment decisions. Finally, there are instances when your investment doubles or better and you cash out entirely only to see the stock triple or quadruple from there. I have had this happen many times over the decades and there are few worse feelings in investing. I have develop a rule of thumb over the year when it comes to small biotech stocks. It is to sell 10% of your original stake once one achieves a 50% gain, 20% of the original stake after the stock doubles and 20% more if one is fortunate to have your stock triple. The other half of the original stake now rides on the “house’s” money unless something drastically changes on the company’s prospects. That concludes a brief overview of some core themes that will be core drivers behind the formulation of our optimum twenty stock Biotech Forum portfolio.