Feeling Nervous About a Biotech Bubble?
A biotechnology bubble appears to be upon us.
The Nasdaq Biotechnology Index is hovering above 3,500. That’s more than double the level it hit 15 years ago, when investors piled into anything tech-related and got burned. The index fell from that high point and didn't begin soaring again until the late summer of 2011.
My colleagues at Bloomberg News say that the Nasdaq’s biotech companies have returned 500 percent gains to shareholders since 2011, versus 97 percent for the Nasdaq's Internet stocks. The Nasdaq now trades at 2.3 times annual sales overall, while its biotech companies are trading at 10 times annual sales.
People looking for a bubble in the broader tech sector tend to watch biotech moves because those companies –- often venture-backed and often beckoning with potentially explosive results -- are considered barometers of how much appetite investors have for risk.
That's all well and good. The bubble that preceded the Nasdaq meltdown in 2000 saw the biggest market moves and most lofty valuations largely confined to the tech sector. But today, the biotech boom isn't an isolated phenomenon. Equities have lifted off everywhere. But while valuations across many indexes and business sectors are very high, none of it approaches the nutty, stratospheric levels of dot-com stocks in 2000.
Fifteen years ago, during a time of incredible innovation in computing, connectivity and science, the Nasdaq gained more than 500 percent between March 1995 and its March 2000 peak. The S&P 500 and the Dow Industrials gained 180 percent and 150 percent over that same period, respectively.
Fallout from the tech bust was relatively isolated. The economist Jared Bernstein writes that the real estate collapse that came several years later was harder on the overall U.S. economy because home price appreciation had created a broadly-felt wealth effect and thus introduced broadly-felt pain. Stock ownership, on the other hand, is concentrated among the richest Americans, with the top 10 percent of the population raking in about 80 percent of all equity market gains.
The 2001-2002 recession that followed the tech bust was a blip on the radar screen. The Economist says that U.S. output shrank for only two, non-consecutive quarters and unemployment never rose past 5.9 percent. But the housing collapse brought the global economy to the precipice of the worst economic disaster since the Great Depression.
All of which offers some context and perspective for the current biotech fiesta.
Pieces of the biotech boom do feel unique to that sector and share similarities with the exuberance heaped upon privately-held tech companies. (Publicly-traded tech stocks have enjoyed a powerful run as well, but valuations there still aren't as lofty as biotech, for the most part.) The economist Dean Baker recently took the wealthy investor and dot-com mania beneficiary Mark Cuban to task for equating the bubbliness suffusing private tech investments today with the boom in publicly-traded tech stocks of the late 1990s.
Some of the biotech companies that have gone public recently really are making innovative treatments that could cure rare diseases. Spark Therapeutics, for example, has created a treatment for an unusual form of blindness. Biotech companies that don’t have new drugs or therapies in the pipeline yet (about 40 percent of all those that went public last year, in fact) tend to take advantage of an IPO window because they have serious cost burdens –- like multiple drug tests and regulatory approval –- that other VC-backed companies don’t have.
Another factor contributing to the biotech run-up: As companies like Uber and Snapchat wait longer to go public, investors who want access to high-growth companies have had more biotech stocks to choose from than anything else. Biotech companies comprised about 25% of the 275 IPOs launched last year, says the research firm Renaissance Capital.
Biotech stocks that went public in the last two years trade, on average, at 78 percent above their offer price. Renaissance Capital says that’s more than three times the premium that the market gives non-biotech stocks that went public over that same time.
With asset values soaring, venture capital investment in biotech companies jumped by 29 percent last year to $6 billion, making it the second largest investment sector, according to PricewaterhouseCoopers. (Software was the largest venture-backed sector.)
Yes, the valuations of biotech stocks and late-stage, private companies (meaning those that are thought to be close to an IPO) have soared. Internet and cloud computing stocks are up. But equities in general are setting all sorts of records.
Professed market bear Fred Hickey writes in his “High-Tech Strategist” newsletter that the S&P 500’s price-to-sales ratio is at an all-time high. Last year, the S&P never fell more than three days in a row, which Hickey says has never happened in the history of the index.
Fears of a debt bubble have been as loud -- or louder -- than fears of a tech bubble or a biotech bubble. U.S. companies issued $1.4 trillion in debt last year, 27 percent more than at the height of the 2007 credit bubble.
High stock prices and cheap debt have also fueled lots of dealmaking over the past year. And those big deals -- done at big price tags -- are keeping values high for smaller, potential takeover targets.
For example, the biotech startup Pharmacyclics was just bought for $21 billion by a bigger biopharma company, AbbVie. The purchase price was 39 percent more than what Pharmacyclics was worth before the market knew about a potential deal. The more competitive the M&A world gets, the more that public investors are always willing to pay.
Low interest rates also help explain why investors are clamoring for risky assets right now.
After the dot-com bust, then-Federal Reserve Chairman Alan Greenspan dropped interest rates in 2001 to their lowest level in 40 years, and rates hovered around 1 percent throughout most of 2004. Rock-bottom rates spurred investment in higher-risk assets, including mortgage-backed securities, that led, in part, to the housing bubble.
In the wake of the Great Recession that began several years ago, the Fed cut rates to zero in order to stimulate economic growth and to forestall a depression. A side effect was to encourage a move into riskier assets that provided better returns than plain vanilla bonds and bank accounts -- equities, high-yield bonds, venture-backed private companies and high-flying biotech stocks.
The rate move has, indeed, buttressed the U.S. economy and set it on a path to revival -- or at the very least it made the U.S. seem like the least bad place to invest right now. Growth in most of the rest of the developed world has lagged the U.S., where unemployment is now just 5.5 percent.
If these trends hold, investors from around the globe may keep piling money into U.S. asset classes that are zooming ever higher, at least through the end of the year. You know, asset classes like biotech stocks.
But then what happens?
The last big biotech bubble reflected an irrational mania for just one kind of risky investment. Today's zeal has investors embracing almost anything that delivers better relative returns. If we ultimately see a big crack emerge in the biotech market, it will be worth looking around to see if that fissure extends into tech stocks -- and into broader indexes and sectors as well.
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
To contact the editor on this story:
Timothy L. O'Brien at firstname.lastname@example.org