By Ben Levisohn
In a note this morning, BofA Merrill Lynch’s Christina Giannini and team note that the risk for big-cap biotech stocks–think Gilead Sciences (GILD) and Biogen (BIIB)–and small-cap biotech stocks–everything else–are quite different. They explain:
Biotech is now more passive than actively managed: Perhaps due to the difficulty picking stocks within such an idiosyncratic sector given the complicated science or unwillingness to take binary risk on trials/approvals, Biotech ETFs have gained popularity as a way to gain exposure to the sector (long or short) over the last few years. AUM for the sector in mutual funds had closely tracked that of ETFs until 2013, since then, flows into ETFs have dramatically outpaced flows into mutual funds and now the AUM of the sector is two-thirds passive vs. one-third active. This creates the risk that the stocks could behave similarly during a sell-off, with greater outflows from ETFs, which we saw during 2014’s sell-off.
Analyst optimism at a 13-year high for small-cap Biotech Analysts have grown more and more optimistic within small-cap Biotech: 80% of analysts’ ratings within the space are a Buy, the highest since ‘02. Meanwhile, 64% of large-cap Biotech ratings are a Buy, below highs in ‘01 (82%) and ‘09 (73%). Increasing small-cap Biotech optimism has been highly correlated with the number of IPOs; meanwhile, the proportion of Buy ratings in large-cap Biotech has a much stronger (negative) correlation with GDP growth.
Biggest risk to large cap Biotech: everyone’s already there: While large cap Biotech looks more attractive fundamentally (as well as technically); the industry is extremely crowded and could serve as a source of funds if investors are forced to close their underweights in more cyclical sectors. And there is a big catalyst for a change in leadership in the next few months: the first Fed rate hike in almost a decade, signaling a better economic outlook and potential upside for neglected GDP-sensitive stocks.
So is biotech a bubble? Maybe, maybe not. But don’t overlook these risks.
Shares of Gilead Sciences are little changed at $117.88 at 9:44 a.m. this morning, while Biogen has dropped 0.5% to $315.39. The iShares Nasdaq Biotechnology ETF (IBB) has gained 0.8% to $381.99.
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