By Lewis Krauskopf
NEW YORK (Reuters) - Sluggish U.S. biotech shares could require a wave of deal-making or exciting clinical trial results if the sector wants to join the stock market's party after lagging Wall Street's broad advance this year.
More certainty about the direction of prescription drug regulation, including the prospects for tougher pricing legislation, also could bolster the stocks.
An index of S&P 500 biotech companies is up 2% so far in 2021, while the overall S&P 500 has gained more than 18%. A closely watched ETF that better measures small and mid-cap biotech companies -- the SPDR S&P Biotech (NYSE:XBI) ETF -- is down nearly 10% for the year, and 27% from its high reached in February.
About $2.5 billion has flowed out of healthcare ETFs on a net basis since Aug. 31, or about 3% of total assets of those funds, according to Jefferies (NYSE:JEF) strategist Steven DeSanctis. In the week ending Oct. 6, the SPDR biotech ETF saw its biggest weekly outflow on record, according to Refinitiv Lipper data.
After a strong 2020 particularly for smaller biotech stocks, investors said the group was due to back off. But biotech shares have been lost in broad investment themes this year, market watchers said.
They cited a tug-of-war between stocks expected to shine in an improving economy, such as energy and banks, and big tech and growth shares that strengthened during economic unease.
“It seems like healthcare, and biotech specifically, is sort of in no man’s land on a year-to-date basis,” DeSanctis said. “The swings in the market have either been, I want to own cyclicals and or I want to be defensive.”
Among large biotech stocks, Amgen (NASDAQ:AMGN), a member of the Dow Jones Industrial Average, is down 10% so far in 2021, while Vertex Pharmaceuticals (NASDAQ:VRTX) has slumped 23%.
The S&P 500 biotech index trades at price-to-earnings ratio of 10.2 times forward earnings estimates, a 50% discount to the S&P 500's P/E ratio of 20.4, according to Refinitiv Datastream data.
“When you look at the large caps, the growth opportunities and the prospects there are a lot more in question than they have been historically,” said Marshall Gordon, senior healthcare analyst at Clearbridge Investments.
For smaller companies, investors often look for a pickup in acquisitions to help improve biotech valuations. Healthcare companies are sitting on almost $500 billion in cash, a record amount, according to Jefferies analysts.
"If we start to see more M&A, that should help trigger more positive sentiment around the space,” said Sahak Manuelian, head of equity trading at Wedbush Securities.
Not all biotech stocks have struggled this year. Shares of COVID-19 vaccine makers, Moderna (NASDAQ:MRNA) and BioNTech, have surged more than 200% so far in 2021.
But recent industry setbacks could be souring sentiment: Biogen (NASDAQ:BIIB)'s new and controversial Alzheimer's treatment has had an uncertain launch, Apellis Pharma shares tumbled following disappointing data for its experimental eye drug, and U.S. regulators placed a hold on studies of Allogene Therapeutics (NASDAQ:ALLO)' cancer medicine.
Data in coming months from major medical conferences, including a hematology meeting in December, could reinvigorate interest in biotech, Manuelian said.
Regulatory obstacles also persist. SVB Leerink analyst Geoffrey Porges said in a note this week that it was "difficult to see" a broad rally in the biopharma group in part because of "the enduring overhang of drug pricing regulation risks, which in our view is likely to last until the end of the year."
Uncertainty about the Food and Drug Administration, the industry's main regulator for which President Biden has yet to nominate a permanent commissioner, may also be clouding the investing environment, investors said.
"There have been a number of regulatory decisions that have been surprising," Gordon said. "There are concerns that FDA is either getting harder or is just less predictable."