Odd Biotech Action Is Creating Opportunities for Deal Hunters
Let’s see how the best trades are often found by looking past the indexes and digging into what is going on inside a sector.
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The day after three major indexes hit new all-time highs, the market is under significant pressure. Breadth is at 28%, which is near the lows we have seen recently. Small caps continue to lag, down 1.3%. New lows are around 250, better than some recent readings and reflecting a slight increase in bottom fishing.
The new highs in the indexes are a classic Market Beast move to trap overconfident bulls who want to believe index highs mean everything is great. It looks good in the headlines, but it hides some structural problems that are causing high levels of consternation.
Unusual Biotechnology Action
If you only watched the indexes, you would have missed one of the more unusual moves in the market this year. On Tuesday I mentioned that degrossing — or cutting long and short exposure — by large funds was driving much of the selling in biotech, and there is now some good data on what has been happening. It is a reminder that the best opportunities are often found by looking past the indexes and digging into what is going on inside a sector.
Greg Obenshain and Daniel Rasmussen at Verdad published a study calling it biotech’s “GameStop moment.” They track two things that have historically done a good job of predicting biotech returns: how much of a stock is owned by specialist healthcare funds and how heavily it is shorted. Over time, the stocks the specialists own and few are shorting have beaten the stocks the specialists avoid and many are shorting. It is quality vs. junk, as judged by large investors with money on the line.
In August and September, that flipped. The specialists’ favorite stocks sold off and the most heavily shorted names rallied, and the pattern gained traction across the whole sector. The more a stock looked like something a biotech hedge fund would own, the worse it did.
The Index Hid It
None of this showed up in the sector exchange-traded fund. The SPDR S&P Biotech ETF (XBI) was up about 7% over those two months, yet this morning 62% of all biotech stocks are more than 40% below their 52-week highs. The index tells you the group is fine. The individual stocks tell a different story.
The trigger was Moderna (MRNA), one of the most heavily shorted stocks in biotech. Its cancer vaccine trial results in August helped the stock more than triple in about two months. When a short goes against a fund, its exposure grows even if it does nothing, and funds with strict loss limits are forced to cover shorts and sell longs at the same time. As more funds do it, the stocks everyone owns keep falling, and the pressure to cut exposure builds on itself.
Inefficiency Is the Opportunity
This is the kind of action that creates mispricing. The selling has nothing to do with whether a drug works or a launch is on track. Stocks are being sold because of who owns them, not because of what the companies are doing. Verdad notes that the specialists’ favorites are now much cheaper relative to the stocks they dislike than they were before the selloff.
The catch is that the same forces that create the opportunity make it difficult to act on. Forced selling doesn’t stop at a logical level. A stock with good news can fall regardless of the positives, and a bounce can be sold the next morning when another fund needs to cut. Charts break down, support levels fail, and the price action gives you no reason to be confident. That is why the inefficiency exists. If it were easy to buy, it wouldn’t be cheap.
Game Plan
I see some great opportunities in biotech, and I’ve mentioned names like Xeris Biopharma (XERS), Precigen (PGEN), BridgeBio Pharma (BBIO), Absci (ABSI), Harrow (HROW) and TG Therapeutics (TGTX), but there is no stability in the sector, so it is risky to get too big too fast. My approach is to start small, buy in pieces across a wider zone than I normally would, and keep plenty of capacity in reserve in case the selling has further to go. I’m not trying to catch the low. I’m watching for two things: crowded shorts like Moderna continuing to fall, which eases the pressure to sell, and the quality names starting to hold on days with no news. When both happen, I’ll add more aggressively.
If you are so inclined, this is a good time to separate the biotech stocks falling on their own news from the ones falling only because of who owns them. The second group is where the opportunity is.
At the time of publication, DePorre was long XERS, PGEN, BBIO, ABSI, HROW, TGTX.
