Biotechs Cheer, Drugs Jeer Rate Cut

The Fed's surprise half a percentage point rate cut Wednesday gave joy to biotech investors worried that their stocks may be teetering on the edge of the chaos that engulfed other Nasdaq stocks. But the market's renewed tech-love came at the expense of "safe" drug stocks.

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The volatile Nasdaq Biotech Index, after slumping most of the morning, jumped 46.3 points, or 4.5%, to 1067 after the Federal Reserve dropped its rate cut on the market amid fears the economy is slipping into a dreaded recession. The beleaguered Nasdaq Composite jumped even higher, rising a whopping 284.5 points, or 12.4%, to 2576.4.

Analysts said the rate cut triggered a shift of funds out of drug stocks, which in recent months had become one of Wall Street's favorite parking places for low-risk growth, pushing valuations to what some said were unsustainable levels. The Amex Drug Index, which gained 51% since March, slumped 4% Wednesday, down 17.6 points to 423.4.

Some analysts speculated that the rate cut, which came between the Fed's regularly scheduled meetings, could mean that the Fed thinks that economic conditions are worse than previously believed.

"It's clear that the Fed believes that things are a lot worse than they are letting on," says Stefan Loren, biotech analyst with Legg Mason Wood Walker in Baltimore. "This restores a little bit of confidence that the Fed will cut rates more and be more responsive."

Ironically, Loren said that while the rate cut could form the beginnings of a mini-rally in biotech, it could actually damage biotech finances, since newly cash-rich biotechs are increasingly using interest to generate operating funds. The industry raised some $39 billion in new funds last year, it's best year ever, according to investment bank Burrill & Co., giving it the capacity to generate substantial funds from interest alone. Still, a rate cut is preferable since a rising share price enables these mostly loss-generating companies to raise even more capital from investors over the long term.

Meanwhile, no one is predicting a sustained exodus out of drug stocks as investors pile into higher growth stocks. It's likely more rate cuts would have to follow before drug companies see investors develop full-blown tech-love and abandon boring Old Economy stocks.

"We're seeing this as a buying opportunity," says Bert Hazlett, drug analyst with Robertson Stephens. "Drug stocks will bounce back over time. It may take a day or a few weeks. These stocks represent an excellent growth story."