Every sell off starts the bubble talk and the more severe the selling the more intense the bubble talk. What is interesting about this time is that the bubble talk has a broader audience as the sector seems to have been on more radars. As I have been saying for awhile, this sell off is likely not done and with all the bubblers out in full force it is probably still the case. For a well written bubble argument, check out the reformed broker’s article. As I also have said before, if you truly believe that biotech is in a speculative bubble (like tulip mania, internet bubble, and so on) then sell all your biotechs and avoid the sector for a decade as we likely have 90% more downside. I know that seems extreme but speculative bubbles are distinct phenomenon which are different than simple market cycles. For those interested in a discussion of the current research on bubbles check out this paper. Bubble or not the sector is hurting and a lot of valuation is being removed and it is never pleasant to experience. That being said if this is simply the working off of an overvalued sector, then it is a matter of waiting for and buying at points of long term value as opposed to leaving the sector.
1. At this point I think GILD is a leading indicator for the sector, which might be good because it is approaching really good long term value. We are not there yet but if you believe that GILD will bottom out at trough PE ratio (which is usually at 8) and that it is on pace for earning $8/share in 2015, then you get $64 as the bottom. Obviously it can overshoot that number if it gets to lower than previous trough PE or if the market does not believe the $8/share earnings in 2015 or if sentiment runs to a negative extreme. That being said at some point GILD becomes a long term bargain and whether that is $70, $65, $60 or something else depends on your assumptions. I still think that the mid-$60s should be trough valuations but given the current sentiment, I could see it overshooting those values. It could also not reach those values either. As I have been saying, I am not a market timer nor do I want to be one nor do I play one on TV nor did I sleep at a Holiday Inn Express last night. I will be buying stocks that I think are hitting values that seem cheap knowing that they may get cheaper. No reason to use all of your cash at once trying to pick a bottom. Also, it depends on your game plan. I am happy to sit and hold through sell offs but it is also a reasonable strategy to wait until we get a more clear reversal of the down trend and save yourself the mental anguish of holding something going down.
2. So what would an end of the sell off look like? Well, the sector stop going down. Yes, I am being a little sarcastic but more seriously I do not think the sector reverses as a group. It seems most likely that the larger caps find their footing first and then it trickles down into the riskier parts of the sector. Whether this is simply the value investors returning or these companies deploying cash to stop the bleeding is not known but these are the stocks that will stabilize first given a more clear valuation floor. As such, if you are waiting for a little bit of an all clear, I think large caps are the canary in the coal mine. I would also keep an eye out for a dead cat bounce as the sector is so oversold at this point we are bound to get a bounce sooner or later. The key is whether the large caps will be able to hold the new lower lows and set a higher low.
3. We have been wonder why FMI has been selling off (perhaps it was just me) and it looks like a large secondary is coming. The company filed an S-1 for a hefty $150M last week. This secondary should offer a good price for investors to initiate or build to an existing position. As I have noted before, FMI is not your typical catalyst biotech and there are many haters of the diagnostic space. That being said, I think FMI is creating a nice moat around its product and one that should allow them to keep a dominant position in this market. The question is whether there is actually a market to dominate and that is where the diagnostic bears make their argument. FMI is either going to need to convince patients to pay for their tests out of pocket or convince insurance companies that the added expense of the test is worth it over the long run. I think the science backs the value argument in that the tests help patients receive medicines that give them their best chance but it is a case that needs to be made and will take time. If you do not think insurance companies can be convinced then stay away from this sector but if you are bullish on this prospect then FMI is worth a look.
I will end it here and I hope everyone has a better week than this morning started.
Disclosure: Long GILD and FMI.
