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Investors Business Daily
Investors Business Daily
Technology
ALLISON GATLIN

Something Unusual Is Happening Right Now With Biotech Stocks

The stock market is struggling, yet scores of biotech stocks are surging like it's a new bull market, all the way from top-rated Catalyst Pharmaceuticals, through such heavy hitters as Neurocrine Biosciences and BioMarin Pharmaceutical, on down to relatively unknown Karuna Therapeutics.

The biotech companies owe their sudden prosperity to a multitude of forces, not just one catalyst. And analysts say that bodes well for their staying power.

Acquisitions by Big Pharma companies, strong earnings and a promising regulatory environment have helped biotech stocks stage a turnaround. And the tantalizing prospect of good news involving CRISPR gene editing later this year adds more fuel. Though biotech stocks have pulled back somewhat in recent weeks and a continued climb isn't assured, the sector ranks seventh for price performance in recent months out of the 197 industries that Investor's Business Daily tracks.

While the broader market has grappled with rising interest rates and inflation, biotech stocks have continued to put out good clinical news — the lifeblood of the industry, says Brad Loncar, chief executive of Loncar Investments. His firm provides the indexes for two exchange traded funds focused on biotech stocks.

"What's exciting about biotech is regardless of how stocks are trading on any given day, lately the fundamental news that determines whether biotech is going forward or backward has all been good," Loncar told Investor's Business Daily. "All the arrows have been pointed in a positive direction."

He notes biotech stocks were the first industry to turn down, starting early last year. Now, they're among the first to turn back up.

Biotech Stocks: A Force For The Future?

Just six months ago, the biotech group ranked No. 143 out of 197 industries, putting it near the bottom quarter of all industry groups. Since then, the best biotech stocks have powered the industry to a seventh-place ranking and a collective Relative Strength Rating of 96. This means the group ranks in the top 4% of all industries in terms of six-month performance.

According to IBD research, groups that start showing strength in the later stages of a bear market often lead the next bull market. A number of biotech stocks also are setting up for strong growth. They include No. 1-rated biotech stock Catalyst Pharmaceuticals, which is expected to report its biggest-ever profits in 2022-23. Catalyst shares have more than doubled since July.

BioMarin Pharmaceutical is poised to report triple-digit earnings growth next year. The biotech stock ranks 12th in the industry group. Vertex Pharmaceuticals, meanwhile, is continuing several years of stock gains as the cystic fibrosis giant paves a new path in blood diseases with gene editing.

Sarepta Therapeutics and Neurocrine Biosciences also are putting in strong runs on investors' enthusiasm for their late-stage product pipelines.

It's been a while since biotechs went on a sustained run; the last was a major surge that started in 2011 and finished up in early 2015. The question now is: Can biotech lead the next bull market?

"It should," said Thomas Swalla, chief executive of privately held Dotmatics. Dotmatics makes software that helps life sciences companies. Swalla notes instrumentation, machine learning and data science are all driving faster, more robust discoveries in drug development.

"I certainly don't see any reason why biotech can't be a huge force in the future," he told IBD.

The Downturn For Big Pharma

The bullish turn for biotech since June has come in lockstep with a downturn for Big Pharma stocks. Just three months ago, the pharmaceuticals group ranked No. 34 out of 197. It has now tumbled 100 spots, ranking No. 134.

Earlier this year, rising interest rates and inflation worries sent investors scrambling for less risky stocks. In the world of medicine, Big Pharma fits that bill. Pharmaceutical companies sell widely used products like cholesterol and cancer drugs. Biotech companies, on the other hand, are working on cutting-edge treatments where losses outnumber game-winning touchdowns.

Then, investors "cared a lot more about businesses that have predictable cash flows today, as opposed to the businesses that have the promise of really big predictable cash flows in the future," Swalla said. "I think biotech and technology stocks suffered the same fate from an institutional investor standpoint."

But now, experts say the paradigm is shifting from a "risk off" environment favoring companies with stable, predictable cash flows to more growth-oriented plays. And when it comes to growth, biotech tends to be among the most eye-catching segments.

Lee Brown, sector lead for health care at research firm Third Bridge, says biotech stocks could actually offer investors a safe haven amid economic uncertainty.

"If you're worried about the economic climate for next year, then being in more idiosyncratic growth sectors is right out of the portfolio manager playbook," he told IBD.

Eric Schiffer, who chairs private equity firm The Patriarch Organization, has a more measured view. He says biotech remains tied to macroeconomic woes, but these stocks have been more beat-up than others and could offer investors a low point for entry.

"What we do know is there's incredible discoveries ahead that will be worth millions of dollars," he said. "We're in a cycle. This is a cycle that will see a bull period ahead. We just don't know when. If investors have a long enough ride, they can do fine. They're getting in at great valuations."

Biotech Stocks Rally On Clinical News

Some of those discoveries are already paying off. Recent studies from Karuna Therapeutics, Alnylam Pharmaceuticals and Regeneron Pharmaceuticals were particularly important for biotech stocks.

Alnylam tested its RNA interference approach in patients with an inherited condition that causes abnormal protein to build up on the heart. The drug, called patisiran, lengthened how far patients could walk in six minutes — a marker of heart health.

Patisiran already sells as an approved drug called Onpattro for patients with the nerve component of the same disorder. But the heart-disease population is much bigger.

"Before then, most of the diseases that Alnylam's technology worked for were rare diseases that only impacted small patient populations," ETF index provider Loncar said. "But this was related to a heart disease that's part of a larger population. So, it hit in a mainstream way."

Alnylam's news sent biotech stocks climbing a collective 4.2% on Aug. 3. Then, shares popped another 2.1% Aug. 8 on Karuna's schizophrenia treatment study results.

New Class Of Schizophrenia Drugs

Karuna's drug led to a strong reduction in symptoms after just five weeks of treatment.

The biotech is now worth $8.5 billion and its stock has a best-possible Relative Strength Rating of 99. That puts Karuna shares in the top 1% of all stocks in terms of 12-month performance, according to IBD Digital. If approved, the drug could lead to an entirely new class of schizophrenia drugs.

The results underscore "the monetization of innovativeness," RBC Capital Markets analysts said in a mid-July note to clients.

Also, Seagen and Astellas Pharma said in July that adding their drug Padcev to Keytruda — the latter is a blockbuster drug for big pharma Merck — led to strong responses in patients with untreated bladder cancer. Biotech stocks celebrated by climbing 1.6% the following day.

Later, in September, Regeneron unveiled promising results in two eye-disease studies, leading biotech stocks to ramp a collective 3.5% in a day.

The Biotech Train Isn't Stopping

The catalysts around biotech stocks are expected to continue this year and next.

Investors zeroed in on the Alnylam, Karuna and Seagen data releases earlier this year, RBC analyst Gregory Renza told IBD.

"The ask was, No. 1: Are those catalysts that were coming this summer really going to drive the sector, (and) how important are they?" he said. "Now that those have passed, the next question is: What's the next big catalyst? That's a tough one."

Instead of one big catalyst, experts generally see a string of smaller catalysts dominating the space in the second half of 2022 and early 2023.

Biogen and Eisai are expected to unveil additional test results for lecanemab, a potential Alzheimer's disease treatment. After Biogen's Aduhelm flop — the Food and Drug Administration approved it, but the Centers for Medicare and Medicaid Services largely declined to cover it — positive news for lecanemab could give the biotech stock a much-needed boost.

Roche has a similar drug in testing.

A hit in Alzheimer's disease "could open up a mostly untapped $15 billion market for biopharma for the first time since the Covid vaccines and hepatitis C drugs," RBC analysts said in a report. It could also "bring new money back into the space with the enthusiasm a favorable result would generate."

New Filings, Data From Biotech Stocks

Following the wild card approval of Bluebird Bio's $2.8 million gene therapy, Zynteglo, Sarepta will file its request for approval of another gene therapy earlier than expected, Loncar says. Bluebird's drug treats sickle cell disease, while Sarepta is working on Duchenne muscular dystrophy.

The Bluebird approval was far from a sure thing, and points to the FDA's willingness to consider newer technologies. Before the approval, the FDA's panel of experts unanimously said the benefits of the gene therapy outweigh its risk in sickle cell patients.

"That was really important for the entire gene therapy field and, therefore, for the whole biotech sector, because gene therapy is such a key component of biotech," Loncar said. "That's like the medicine of the future. That's going to affect the development of gene therapies and gene editing going forward."

Related to that, Crispr Therapeutics and Vertex are expected this year to ask the FDA to approve their CRISPR gene-edited drug for patients with sickle cell disease and beta thalassemia. That will be a first for any CRISPR drug, ever.

The Crispr drug is an ex vivo treatment. This means the gene editing takes place outside the body. But Verve Therapeutics is working on an in vivo approach to high cholesterol. In vivo therapies edit genes inside a patient's body. The only in-human data, to date, comes from Intellia Therapeutics. Verve's drug would go after the large, high cholesterol market.

"As we look to the coming months, we cannot think of another time in history where the FDA will be tasked with making decisions on so many novel modalities — all at once," the RBC analysts said.

Big Pharma Acquisitions Of Biotech Companies

All of this comes amid a backdrop of accelerating biotech takeovers.

Bristol Myers Squibb bought Turning Point Therapeutics for $4.1 billion, adding to its cancer portfolio.

Pfizer is doubling down on migraines and sickle cell disease with the acquisitions of Biohaven Pharmaceuticals and Global Blood Therapeutics for a respective $11.6 billion and $5.4 billion.

Amgen will spend $4 billion to buy ChemoCentryx.

Most recently, Novo Nordisk joined the fray with its $1.1 billion acquisition of Forma Therapeutics. Forma is also working on a sickle cell disease treatment.

Meanwhile, Merck is reportedly interested in a Seagen takeover. The companies already partner together in cancer drugs. The deal would be worth around $40 billion, according to reports, and would be Merck's biggest transaction in a decade.

Big Pharma Companies Go Shopping

Big Pharma's appetite for biotech stocks makes sense from two perspectives.

William Blair analyst Tim Lugo notes Congress recently signed off on new drug price rules. Beginning in 2026, Medicare will be able to negotiate the cost of some small-molecule drugs — these tend to be pills produced by pharma companies — nine years after they launch.

Medicare has never been able to negotiate drug costs. This is a shorter time period than the 13 years biologics will enjoy. Biotechs tend to make biologics.

And many Big Pharma companies will soon lose patent protection for their bread-and-butter products. A prime example is Merck, whose biggest moneymaker is cancer treatment Keytruda. The first Keytruda patent will expire in 2028. AbbVie's Humira, used to treat arthritis, Crohn's disease and other conditions, will face generics in the U.S. in 2023.

Against this backdrop, biotechs look particularly enticing for big pharmaceutical companies, which sorely need new innovation, William Blair's Lugo told IBD.

"Pharma needs new pipeline assets and that's where biotech thrives," he said. "The (biotech) sector used to sell off when drug pricing was discussed in broad strokes. But now that we have a framework on drug-pricing regulations and the products targeted, it makes sense there will be more (mergers and acquisitions) in this space."

An Earth-Shattering Catalyst?

The biggest potential catalyst heading to the end of the year will be the Merck and Seagen deal — if and when it happens, says RBC's Renza.

But that's far from driving all biotech stocks. Much of that strength can be seen in the chart action for the industry group. Shares bottomed out in mid-June and have tested their 50-day moving average three times since.

Every time, biotech stocks have managed to stay above that floor, according to MarketSmith.com. Even now, the stocks still have room to move higher, some experts say.

In some ways, the string of upcoming catalysts is a sign of fundamental strength returning to biotech, Renza says.

"I think a broad set of catalysts across the space and not being able to point at one earth-shattering catalyst for the year probably speaks to a sector that's working well where risk is spread," he said.

Follow Allison Gatlin on Twitter at @IBD_AGatlin.

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