Profit With the Sharks in the Biotech Market

Stocks can’t recover from yesterday’s rout triggered by CBS naming Stephen Colbert as David Letterman’s replacement.

Forgive us for not-so-gently mocking the financial media. “Whenever we see any sort of disruption in markets, an explanation usually follows,” money manager and uber-blogger Barry Ritholtz muses this morning.

“Stocks are fully valued, and have been for a while, so why is it that valuations suddenly matter after not mattering at all? The market for initial public offerings is too hot? Wait, the Federal Reserve is going to end quantitative easing, something it has been warning us about for two years? Now it suddenly matters?

“All of these narratives serve a singular purpose: They give the appearance of meaning and rationality to actions that are meaningless and irrational.”

That is, all the media’s explanations for the Nasdaq tumbling 3% yesterday make as much sense as the Colbert announcement.

“Biotech Stocks’ Rout Perplexes Analysts,” says a Wall Street Journal headline this morning — which amuses Mr. Ritholtz no end.

“There are several things that make this such a wonderfully inadvertent truth-telling exercise. The headline implies that other times when stocks get shellacked, the analysts know and understand the reasons why. Never mind that they cannot forecast where these stocks will go, and all of their explanations are post-hoc rationalizations. But this time, they are perplexed.”

There’s a good reason they’re perplexed. We’ll get to that…

Biotech and Internet stocks are “highly vulnerable because they’re in cuckoo-land in terms of valuations,” says the estimable Marc Faber.

“They have no earnings. They’re valued at price-to-sales. And this is not a good metric in the long run,” he told CNBC yesterday.

We explored the “Is biotech in a bubble?” question as 2013 drew to a close. Not being an expert in the field, we refrained from venturing our own opinion… but we did gently suggest that when a sector leaps 60% in a calendar year, it’s due for a rest. The Nasdaq Biotechnology Index topped on Feb. 24, and has tumbled 19% since.

“When you see something on TV or read something on a website or hear your neighbor say something about biotechnology stocks, I want you to forget it instantly,” writes Paul Mampilly.

Mr. Mampilly is another addition to our quickly expanding team… and he is an expert in the biotech field. With 25 years of investing experience, he remembers well the most important moment for investing in biotech stocks. It was 1999. He’ll tell you what made it so important — and why it’s relevant now — in a moment.

But first, let him tell you why you should tune out most of the noise about the sector. “Even analysts at the average mutual fund or hedge fund covering biotechnology stocks are probably 30 years old,” says Paul. “In other words, these analysts are green, meaning they have two years of experience or less with these stocks. And these two years have been good ones. I have a name them for these kinds of analysts: good-time Gantrys.

“These good-time Gantrys have only seen stocks go up. So they have no experience in understanding how to read and understand the ups and downs unique to biotech investing.”

“Biotech investing is like the highest of high-stakes poker games in the world, with the sharpest of poker sharks playing,” Paul goes on.

“If you don’t know the rules, you’re going to lose money — a lot of money. If you know the rules and play it right, you can make a lot of money.”

Which is the reason 1999 matters: “That was the year the human genome was first decoded. In other words, that was the first time we were able to look into our bodies and see what genes we have. Second, it was also the year that marked a huge biotechnology bubble that birthed most of the companies that dominate the stock market in this area today.

“I remember these companies the way that older people go up to kids and tell them they knew them when they were little tykes. I’ve known companies like Gilead, Celgene, Alexion and Biogen Idec and others since they were babies. I have a unique appreciation of how all their good work is paying off for them.”

And now? “I believe we are in a golden age for biotechnology and investing in biotechnology. The medical breakthroughs we are going to see in the coming decades are going to make fortunes for some investors.”

Regards,

Dave Gonigam
for The Daily Reckoning

Ed. Note: Mr. Mampilly is currently “beta-testing” a brand new service with a select group of readers — identifying key inflection points that can drive biotech shares up very high and very fast, like FDA approvals. And when the test-phase is over, readers of The 5 Min. Forecast will be among the first to be able to gain access to his research. To ensure you’re one of those lucky readers, sign up for The 5 Min. Forecast right here.