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Frederic Ruffy, Optionetics.com
October 5, 2001

Healthcare stocks have not escaped the recent market downdraft unscathed.  Shares of biotech companies have been hit especially hard.  The AMEX Biotechnology Index ($BTK), for instance, is down nearly 30% so far this year and those investors expecting biotech stocks to weather the recent storm better than more cyclical sectors of the market have been sorely disappointed.  But, despite the weakness in biotech stocks, the fundamentals of the industry remain unchanged.  For that reason, going forward, the recent drop in share prices might prove to be an overreaction, and serve as an opportunity to establish long-term bullish positions within the biotech sector.

Throughout much of the year 2000, biotech stocks were among the strongest.  Shortly after the technology sector peaked in March, the AMEX Biotechnology Index enjoyed a four-month, 92% surge.  While the index of seventeen major bio-pharmaceutical companies eventually gave back some of those gains, for the year, it was among the best performers.  In fact, BTK’s twelve-month 62% rise was in stark contrast to the 37% drop in the tech heavy Nasdaq 100 ($NDX) last year.

Biotech’s solid move higher last year owed largely to the perception that the industry was immune from the woes that troubled other sectors of the market.  Namely, a slowdown in the US economy would not alter the growth prospects of biotech stocks because the business of producing and marketing drugs is not cyclical in nature.  

Yet, this year, biotechnology stocks have not faired well.  For one, there has been growing concern about the pace of new drug reviews and approval by the Food & Drug Administration [FDA].  In fact, over the past few months, the administration has rejected a number of high-profile drugs. For example, in mid-July, news that the approval of an anti-asthma drug, Xolair, from Genentech (DNA), had been delayed shook the biotech sector (see Index Intelligence: What is the Best Bet For Biotech?, 8/10/01, for more on the FDA and biotech drug approvals).

In addition, given the steep decline in the stock market over the past several months, investors have become more risk averse. As a result, biotechnology stocks have suffered because many companies within the sector are still unprofitable. For example, of the seventeen components of the biotechnology index, only eight have posted actual earnings this year and the average price-to-earning ratio afforded to those eight is a whopping 155.75.  In addition, investor reluctance to take on risk appears to have grown since the terrorist assaults of September 11.  In the week immediately following the attack, the biotech index tumbled 17%.

Yet, while an aversion to risk and the terrorist attacks have hurt biotechnology stocks in the short-term, they have not changed the underlying fundamentals of the industry.  Of course, there were some problems directly associated with the events of September 11.  For instance, Cor Therapeutics (CORR) told investors that it would miss sales and profit expectations for the third quarter because patients delayed elective heart operations.  During the week of September 11, patients postponed surgery and watched television coverage of the terrorist attacks instead.

In the big picture, however, the terrorist attacks and the FDA’s slower drug approval process does little to change the long-term growth prospects of the biotech industry.  Some companies, such as Millenium Pharmaceuticals (MLNM) and Protein Design Labs (PDLI), are far along in research and development of certain treatments for cancer and other diseases.  Some new drugs are likely to be presented in the fourth quarter.  As another example, on October 4, an advisory panel to the FDA supported approval of Gilead Sciences’ (GILD) new HIV drug, Viread.  In short, through research and development, biotechnology companies have been filling the drug pipeline and, for some, the result will be a sales and profit windfall. Eventually, those biotech companies capable of producing and marketing successful new treatments are likely to see their share prices rise astronomically.

Perhaps the reason investors are not focusing much attention on the long-term prospects in the biotech sector today owes to the happenings within other areas of the stock market.  For one, there have been some high profile disasters within the Internet sector.  As an example, Exodus Communications (EXDS) filed for bankruptcy protection last week.  Interestingly, EXDS, which was a component of the Nasdaq 100 Index, is being replaced by a biotech stock.  Specifically, Gilead Sciences is joining the Nasdaq 100.  In addition, Standard & Poor’s recently said it was adding biotech giant Immunex (IMNX) to the prestigious S&P 500 Index ($SPX).   Therefore, it appears that developers of two of the key stock market indexes are betting on biotech, and that, in turn, makes a compelling case for the industry’s long-term prospects.

AMEX Biotech Index ($BTK)
Statistics
Implied Volatility	56%
Historical Volatility: 50-day	47%
30-day	48%
20-day	46%
Put-Call Ratio (10/04/01)	.12
30-day Median Put Call	3.13
52-Week High	787.68
52-Week Low	382.38
Price (10/04/2001)	459.08
YTD Return	-27.6%
Average P/E Ratio	155.75
No. of Profitable Companies	8
Number of Components	17
Type of Index	Equal-Dollar Weighted
Exercise Style	European

Over the past few weeks, Index Intelligence covered the following indices:

Date	Index	Ticker
08/13/01	S&P 500	$SPX
08/14/01	PHLX Bank Sector Index	$BKX
08/16/01	Dow Jones Industrial Average	$DJX
08/17/01	PHLX Semiconductor Index	$SOX
08/20/01	European-Style S&P 100	$OEX
08/22/01	AMEX Natural Gas Index	$XNG
08/23/01	Nasdaq 100 Index Trust	QQQ
08/24/01	AMEX Pharmaceutical Index	$DRG
08/27/01	PHLX Oil Service Index	$OSX
08/28/01	S&P Retail Store Index	$RLX
08/29/01	DJ Transportation Average	$DTX
08/30/01	PHLX Box-Maker Index	$BMX
08/31/01	Street.com Internet Index	$DOT
09/04/01	PHLX Utility Index	$UTY
09/6/01	Value and Growth	$SVX $SGX
09/10/01	S&P Chemical Index	$CEX
09/17/01	AMEX Airline Index	$XAL
09/18/01	Internet HOLDRS	HHH
09/19/01	AMEX Broker/Dealer Index	$XBD
09/20/01	AMEX Japan Index	$JPN
09/21/01	S&P 100	$OEX
09/24/01	AMEX Oil Index	$XOI
09/26/01	AMEX Disk Drive Index	$DDX
09/27/01	PHLX Gold and Silver Mining Index	$XAU
10/01/01	Mini-Nasdaq 100	$MNX
10/02/01	MS Cyclical Index	$CYC
10/03/01	Oil Service Holders	OIH
10/04/01	Russell Small Cap Index	$RUT

Frederic Ruffy
Senior Writer & Index Strategist
Optionetics.com ~ Your Options Education Site
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