Tuesday, March 10, 2015

Biotech Blowoff Beats Even Dot-Com Madness

Annual health tech fests like the JPMorgan Health Care Conference, Biotech Showcase, and One Med Forum came and went this year in San Francisco.  The star performers in this sector no doubt have a lot to brag about.  They will also have a lot of explaining to do when the biotech and health care sectors eventually crash.

The NASDAQ Biotechnology Index (NBI) has only been around since November 1993.  It does not have as much history with the United States business cycle as the S&P 500.  Retail investors did not need to pick stocks in this sector to compensate for whatever they lost in the 1990s dot-com crash.  The iShares Nasdaq Biotechnology ETF (ticker IBB) was priced at $95.32 at inception on Feb. 12, 2001.  It now stands at $341.43, a healthy gain for anyone who held it through the financial crisis and didn't get spooked when it dropped into the high 50s in March 2009.

Consider that IBB's P/E of 24 signals a valuation far out of whack with what the health care sector of the economy can deliver in the future.  IBB's components are large-cap stocks heavily weighted towards pharmaceuticals.  Specialty drug makers have received an unsustainably large portion of prescription spending in recent years.  The health insurance coverage that sustains all prescription spending is now heavily dependent on ACA subsidies.  Anecdotes about the Affordable Care Act pale in comparison to the government's National Health Expenditure (NHE) data, which show how further projected increases in health care spending through 2023 are strongly driven by ACA coverage expansion.

Continued ACA subsidies, like all other federal discretionary spending, depend very much on the US government's ability to borrow at low interest rates indefinitely.  That is unsustainable.  Any upward movement in interest rates would explode the federal government's interest costs on sovereign debt and immediately crowd out discretionary programs.  The likely effects on politically popular entitlements like ACA handouts would include inflation indexing.  Uncle Sam is an expert practitioner at artificially understating inflation to save on CPI-based entitlement costs.  The end of endless cheap borrowing will bring the end of meaningful ACA subsidies and Medicare reimbursements.  The health care and biotech sectors will not escape that banquet of consequences.

Full disclosure:  No position in IBB at this time.  No position in other health care or biotech stocks at this time.  One small private equity position in one medical device startup.