Biotech stocks gain momentum from lower rates, innovation, and M&A

The end of 2023 capped three consecutive years of underperformance for the biotechnology sector, with the Nasdaq Biotechnology Index delivering -2% per year compared to 10% per year for the S&P 500^® Index. Losses have been worse for the broader S&P Biotechnology Select Industry Index, which includes small- and mid-cap equities, and has returned an annualized -14% over the same period.

This performance stands in sharp contrast to 2020, when low interest rates and excitement about COVID-19 vaccines helped push biotech stocks to new heights. But history shows these drawdowns can take time to run their course (Exhibit 1). The good news: Biotech also has a record of big rebounds, with the sector historically delivering double-digit gains after negative performance. Today, there’s reason to believe a similar recovery could be in the offing.

JHI

For one, the Federal Reserve (Fed) appears to have ended its campaign of interest rate hikes, and periods of stabilizing or declining rates typically coincide with positive returns for biotech. We saw this relationship begin to play out in the fourth quarter of 2023, with the S&P Biotech Select Index jumping sharply on news the Fed might cut rates in 2024 (Exhibit 2).

At the same time, the sector’s innovation is accelerating. In 2023, the Food and Drug Administration approved a record 73 new therapies. Many of these drugs target large disease categories such as obesity, autoimmune disease, cancer, and Alzheimer’s that represent major new product cycles and could drive revenue growth for the next decade. Furthermore, new drug launches could help offset the earnings drag created by waning COVID-19 product sales, improving investor sentiment toward the sector.

Merger and acquisition (M&A) activity also picked up recently and could maintain momentum. Last year, 22 deals valued at $1 billion or more were announced, double the number in 2022. Nearly half of that M&A occurred in the final three months of the year, spurred in part by the U.S. Federal Trade Commission’s decision to let Amgen complete its $28 billion acquisition of Horizon Therapeutics, removing a regulatory overhang. (The deal was finalized in early October.)

Biopharma companies also face a revenue shortfall as a number of blockbuster¹ drugs lose patent protection by the end of the decade. New market opportunities, including GLP-1s (for diabetes and obesity), gene editing, antibody drug conjugates, radiopharma, and cell therapies for cancer and autoimmune diseases could help replace lost revenues. With regulatory headwinds abating, valuations low, and interest rates pulling back, we expect heightened deal activity could continue.

Nevertheless, we do not expect a return to the heady days of the pandemic when biotech stocks could benefit regardless of the quality of a company’s pipeline or balance sheet. Capital markets remain selective, initial public offering activity has yet to rebound, and many firms could face cash shortfalls over the coming 12 to 18 months.

As such, we believe it remains a stock picker’s market – with compelling opportunities available for those investors willing and able to deploy capital in the right opportunities.

IMPORTANT INFORMATION

Health care industries are subject to government regulation and reimbursement rates, as well as government approval of products and services, which could have a significant effect on price and availability, and can be significantly affected by rapid obsolescence and patent expirations.