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U.S. biotechs can’t shake October blues as investors await next moves

Gilead Sciences Inc.'s Truvada is arranged for an illustration at Ansonia Pharmacy in New York on Thursday, July 24, 2008.

JB REED/BLOOMBERG NEWS

A late-summer bull run for biotechnology stocks that propelled them to outperform the broader market floundered after disappointing earnings and a lack of catalysts stopped the group in its tracks.

The sector's 2017 rally garnered attention from generalist and momentum investors who focus more on quarterly sales and earnings than development pipelines and upcoming clinical data catalysts. So when mature-biotech names like Biogen Inc., Gilead Sciences Inc. and Celgene Corp. trimmed guidance or posted third-quarter sales that fell short of estimates, some investors ran for the door.

"What you're having right now is large cap owners rotating out of those stocks and redistributing their portfolios after third-quarter results were weak," Oppenheimer analyst Hartaj Singh said in a phone interview. "That and some profit taking are driving this weakness, not a lack of fundamentals or short selling."

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Sales for biotech heavyweights tend to accelerate as the year goes on, though a strong first half likely set the bar a bit too high for some investors. Biotechs started to slip ahead of the latest financial results, then the group really broke down, JMP analyst Michael King noted.

"There may have been some positioning ahead of time, but third-quarter earnings reports from a lot of the bigger companies weren't great," King said by phone. "These larger biotechs tend to produce earnings that accelerate as the year goes along, but that obviously didn't happen in the third-quarter so investors sold the stock."

Yes, the Nasdaq Biotechnology Index's 5.8-per-cent October selloff is not a complete shock compared with trends over the last ten years, but that weakness is uncharacteristically bleeding into November. October has been among the worst months for the group, falling an average of 2.4 per cent, though it has typically recouped those losses by climbing an average of about 3 per cent in November. If this month's selloff continues, it would result in the NBI's first November slump since 2010 and its first back-to-back monthly drop since early 2016.

The "failed rally" may simply be a sign the sector is following in the footsteps of the latest biotech market cycle, BTIG analyst Dane Leone wrote in a note dated November 15. He says larger capitalized companies may be poised to return to prominence by outperforming the broader market through the beginning of next year.

"Investors will want to see the group show it is able to flatten out before they buy back in," Singh said, noting that "if the pattern persists into early December, we have a bigger problem."

As catalysts that can provide a meaningful lift before year-end are diminishing, investors may be forced to remain on the sidelines and strategically position ahead of updates expected next year. JPMorgan's annual San Francisco health-care conference will probably bring some preliminary results and new forecasts in early January. Also that month, Spark Therapeutics is due to hear from U.S. regulators about its experimental gene therapy, and news for Vertex Pharmaceuticals' next cystic fibrosis regimen may not be far behind.

A combination of the sector stabilizing through year-end, positive clinical updates early next year, and large-cap forecasts falling in-line with expectations should spur the group, Singh said. "If those three things happen, I certainly expect the sector to do as well as it did this year if not better."

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