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Rising Rates and Recession Fears
On Thursday, St. Louis Fed President James Bullard warned that the Fed could raise rates as high as 3.5% to counter inflation.
Unsurprisingly, market commentators immediately forecast a recession. Since Monday, the tech-heavy Nasdaq Composite (IXIC) has fallen 4%, while unprofitable companies like Riot Blockchain (NASDAQ:RIOT) have dropped even further.
Not only do slowing economies bode poorly for high-growth stocks. Rising rates also have a particularly chilling effect on valuations. Growing “discount rates” reduce the value of future profits, making high-tech startups worth less to investors. That’s why value stocks (with high current profits) tend to outperform during times of market stress.
But there’s one high-tech sector that has always bent that rule:
Biotech Are Value Stocks? Really?
Biotech companies have an odd feature. Much like oil companies and gold miners, these healthcare startups also sit on hard assets:
Their drugs in clinical trials.
These drug candidates have immediate transactional value. Managements can always sell these assets, creating a “floor” on stock prices during market drawdowns.
History speaks for itself.
During the 2008 financial crisis, the iShares Biotechnology Index dropped by less than half of the S&P 500’s fall. Biotech would eventually emerge from the financial crisis up 29% vs. a mere 1.5% growth in the index.
And the same thing happened during the 2020 Covid-19 pandemic:
Even now, the pattern is emerging again. The iShares Biotech index has outperformed the Nasdaq composite by 3.5% in the past week as the Fed teases higher rates.
Today, we’ll look at five biotech companies that can help investors weather today’s market volatility. As recession and rate-rising fears grip the market, these Moonshots provide a way to maintain some growth in your portfolio without risking it all.
Five Biotech Stocks to Weather a Potential Recession
Solid biotech investing involves a strong understanding of both medicine and finance. And when it comes to making a profit, two winning tactics stand out.
1. Choosing Promising Treatments
There are always multiple ways to attack any particular disease. Cancer-beating oncology treatments have pursued hormone therapies, apoptosis and even angiogenesis — a method that targets the blood vessels supplying the tumor.
But many pathways turn out to be dead ends. Biogen’s (NASDAQ:BIIB) Alzheimer’s drug Aduhelm failed several clinical trials but went ahead with FDA approval anyway. It’s been a commercial flop.
My general rule for biotech investing is to avoid treatments with questionable pasts. If twenty other companies have already failed at commercializing a particular drug, I wouldn’t bet on the twenty-first to finally get it right.
2. Choosing the “Right” Diseases
Next, let me be clear. Every person deserves medical care, regardless of how rare their condition might be. Governments and private foundations spend billions on treating diseases that affect only a handful of people. This doesn’t just advance science. It’s also simply the right thing to do.
But from a commercial standpoint, investors don’t have the same moral luxury. Spending $1 billion to develop a cure only breaks even if the drug makes $1 billion in profits before its patent expires. And considering that over 90% of drug candidates never make it to production, the actual earnings for the winners need to be even higher.
That means investors need to be dishearteningly selective about the conditions that biotech firms treat. Cancer, diabetes, dementia, heart diseases and other chronic illnesses are unfortunately not only commonplace but far more expensive to treat, making them better targets than those companies pursuing rarer conditions.
I encourage you to donate what you can to medical research. But profiting from biotech investments requires focusing on higher-grossing cures.
When I first recommended Longeveron (NASDAQ:LGVN) in November, shares were trading under $4. The firm had just seen a heavy spate of insider buying, suggesting something was brewing with its leading drug candidate Lomecel-B.
“LGVN executives are acting as if they know something that we don’t,” I wrote in my letter.
It turns out that was right.
Within a month, Longeveron’s management revealed that the FDA had granted Lomecel-B Orphan Drug Designation (ODD) for the treatment of rare heart defects in infants.
Shares immediately shot up to $10 and kept going. A week later, they would hit $45 after Reddit investors picked up on the story.
Now that shares are back to a reasonable $11, it’s time for investors to buy back in. Though Longeveron’s future remains far from certain, a stream of good news from its Alzheimer’s tests provides hope for more significant gains ahead.
Biotech investing also involves making solid valuation calls.
And that’s where Tracon (NASDAQ:TCON) comes in.
TCON started life as a promising small-molecule oncology drug company in the 2000s. Shares eventually peaked at a split-adjusted $175 in 2016 before losing 99% of their value over the intervening years.
But currently trading around $2.50 with a promising new drug in its pipeline, Tracon is now worth a second look.
The company’s near-term future rests on a single drug, Envafolimab, an immunotherapy treatment that received approval from China’s version of the FDA last November.
And the chances of success are surprisingly high. Other drugmakers have already used similar PD-L1 inhibitors to create working cancer drugs: the FDA approved use of AstraZeneca’s (NASDAQ:AZN) durvalumab in 2018, and Roche’s (OTCMKTS:RHHBY) atezolizumab in 2021. Tracon’s subcutaneous PD-L1 antibody treatment could add a similar weapon to the medical arsenal.
With TCON shares valued at $50 million, this is a gamble that’s beginning to look worthwhile.
Entera Bio (ENTX)
In January, I wrote about Entera Bio (NASDAQ:ENTX), a promising biotech firm working on an osteoporosis drug. The FDA had just granted the company a fast track to approval: The firm now only needs to pass a 12-month study on bone density rather than undergo a longer-term fracture study.
It was great news for Entera’s flagship candidate, EB613. Reduced regulatory hurdles increase the chance a company can bring a drug to market. Since then, ENTX shares have risen 20% on positive news of a separate Phase 2 trial.
Fortunately, there’s still time to buy. Markets value ENTX at under $100 million, giving the company plenty of room for upside if more good news emerges.
Greenwich LifeSciences (GLSI)
Occasionally, investors seem to penalize hyped-up CEOs when clinical trials are delayed.
And that seems to be the case with Greenwich LifeSciences (NASDAQ:GLSI), an oncology drug firm that only recently passed its Phase IIb trials. Shares are down more than 70% despite publishing reasonably promising results.
That’s giving investors a chance to buy into practically risk-free biotech play. GLSI’s GP2 immunotherapy treatment led to zero metastatic breast cancer recurrence in its most recent trial, and insiders have been buying up shares in the beaten-down stock.
Though GLSI might only return 2x to 5x from current levels, the risk of total loss is far lower than the average biotech bet.
Luke Lango’s Top Pick
And finally, InvestorPlace’s Luke Lango has also turned his attention to the high-growth world of biotech.
His top pick is quite different from the rest. Rather than pursuing individual therapies, his choice creates a whole platform for developing and manufacturing drugs. It’s a form of synthetic biology that’s enabled technologies from CRISPR/Cas to rapid Covid-19 PCR tests.
And the best thing? The company operates in a potential $80 trillion market… and it looks like Microsoft at 38 cents… Netflix at $1.38… or Amazon at $19.
To sign up for Luke’s stock service and access his pick, click here.
Gaining an Edge in Biotech Investing
Biotech’s high potential comes with a downside:
It’s easy for novices to underperform.
A random basket of biotech companies would have lagged the broader tech market in the past five years. The equal-weighted SPDR S&P Biotech ETF (NYSEARCA:XBI) has only risen 36%, compared to the Nasdaq’s 134% gain.
Many investors are also turned off by biotech’s complexity. Everyone knows what a GameStop (NYSE:GME) store looks like, but it’s far harder to visualize what a drug named Blinatumomab does, let alone how it’s pronounced.
But that also makes biotech a wellspring of inefficiently-priced Moonshots. Even a tiny edge can generate good returns; a large one can create stunning ones.
In other words, a diversified portfolio of biotech bets is a historically solid way of emerging unscathed from even the worst recessions. Investors should take heed.
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On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.