Has the Biotech Bubble Burst?

The bears are back in biotech. Or so it seems. After a year of remarkable gains—accentuated by a near-record number of initial public offerings (IPOs) and 61 percent rise in the NASDAQ Biotechnology Index (the gain is more than double the S&P 500’s 26 percent growth in 2013)—biotech stocks have significantly lost their luster.

The shine was bound to wear off eventually: The industry had been on an incredible roll for the last two years as investor bidding drove company values to dizzying heights. Boston, Mass.-based Biogen Idec, for instance, nearly doubled in value last year, reaching close to $300 per share in mid-December—10 times its trailing revenue and 40 times its earnings.

Such colossal valuations helped inflate the SPDR S&P Biotech Exchange Traded Fund (ETF) trailing price-to-earnings ratio to 33-1 and fueled the sector’s impressively strong start to 2014. The first quarter, in fact, practically mirrored the previous four in terms of investor interest and soaring stock values (at one point in late winter, biotech shares had regained more than 400 percent of their March 2009 nadir).

The quarter also maintained the frenetic pace of public offerings, hosting the debuts of 26 biotech firms—an equivalent to some years’ totals (2000) and more than double the historical annual average of 12, according to Renaissance Capital data. As New York, N.Y.-based financial advisor and Reformed Brokers blogger Joshua M. Brown noted in early spring, “Anyone with a protein compound under a microscope and a clean suit can go public right now.”

Or so it seemed.

In late February, however, biotech’s big boom began to bate. Almost without warning, the bottom dropped out of the market, sending stock values plummeting faster than a free-falling elevator. NASDAQ Biotechnology share value peaked on Feb. 25 then backtracked for seven consecutive weeks (its longest losing streak since 1998), ultimately surrendering 20 percent of the year’s gains through April 15. Between March 10 and April 9, the SPDR S&P Biotech ETF lost 16.93 percent of its value, the First Trust NYSE Arca Biotechnology Index ETF ceded 11.68 percent of its worth, the iShares Biotechnology Index ETF relinquished 3.78 percent and Market Vectors Biotech EFT shares forfeited 7.9 percent.

On April 4, the SPDR S&P Biotech ETF sustained the largest loss since its inception, yielding $372 million, or 7.5 percent, of its $4.98 billion total.

Much of the sell-off coincided with a March 21 Congressional inquiry into the $84,000 price tag of Gilead Science Inc.’s hepatitis C treatment. In a letter to the Foster City, Calif., biopharmaceutical behemoth, Democratic U.S. Reps. Henry A. Waxman, Frank Pallone Jr. and Diana DeGette asked the company to justify its rationale for selling Sovaldi for $1,000 per pill. “Our concern is that a treatment will not cure patients if they cannot afford it,” the trio wrote.

Consequently spooked by pricing pressure concerns, investors yanked 4.4 percent in stock value from the NASDAQ Biotechnology Index, sending the entire sector into a tailspin. Gilead shares fell 4.6 percent the day news broke about the Congressional inquiry and tumbled even further (to 9.6 percent) in subsequent weeks.

Other companies soon followed suit, their share values falling like a line of dominos. Amgen’s stock slipped 3 percent; Biogen Idec shares dropped 8 percent; and Celgene’s stock dipped 3.7 percent.

The bulls were in full retreat. Or so it may have seemed.

As stock prices retreated from record highs, whispers of a biotech “bubble” grew increasingly louder. Analysts, predictably, drew comparisons between the sector’s 2013-14 rally and the 1999-2000 bubble, when U.S.-listed IPOs averaged one-month returns of 56 percent and one-day returns of 53 percent. But experts were divided over the existence of a bubble—proponents insisted the past year’s cavalcade of IPOs and astronomical stock prices (Intercept Pharmaceuticals’ 220 percent overnight return, most notably) proved their point while skeptics considered the meteoric rise and ensuing fall of stock prices a natural “adjustment.” Moreover, the recent glut of IPOs fails to account for the decade-long drought for investors, some analysts argued.

“Numbers are being tossed about to show very high returns but they ignore the preceding, sluggish period,” Forbes contributor John S. Tobey wrote in late March. “Biotechs were one of the laggard groups in the 2009-2011 period, outperformed handily by the Nasdaq index. The biotech decline is not a bubble bursting. Rather, it’s one of those ‘typical’ adjustment periods following a steady run-up. Often labeled profit-taking, it is better viewed as a buyer boycott of paying up any further. An apropos Wall Street saying I was taught early in my career is, ‘When stocks can’t go up, they go down to make room.’”

Biotech’s star surely will rise again. By then, Wall Street analysts might finally be able to settle the great bubble debate. But it’s going to take some time—by definition, bubbles are notoriously difficult to detect before they pop due to their plausible motives. In the 1830s, for instance, the ease and practicality of water transportation sent canal stocks through the roof. Similarly, investors with the foresight to envision the Internet’s groundbreaking impact on global commerce pumped up dot-com stocks in the 1990s.

Biotech’s plausible motive is a bit more murky, though it may very well be that medicine is making some impressive breakthroughs, and doing so after a long dry spell. “Biotechnology is a real, great American story,” Rajiv Kaul, portfolio manager of Fidelity’s Select Biotechnology Portfolio, told USA Today. “It’s very difficult to make medicine. It takes hard work and the failure rates are high. But it’s a really exciting time.”

Despite the bubbles.