The Daily Interview: The Outlook for Biotech Stocks

Biotech investors: Fasten your seatbelts, severe turbulence ahead.

Monday's almost 8% drop in the biotech sector suggests that investors don't have the stomach anymore for high-risk investments, says Stefan Loren, managing director and biotech analyst at Legg Mason Wood Walker. While Loren still believes a sector recovery is inevitable, many of the old rules just don't apply anymore.

We talked to Loren about his reaction to Monday's trading and his thoughts on what biotech investors can expect in the next few days and weeks.

TSC: What's your gut reaction to Monday's biotech sector selloff?

Loren: There is a flight to liquidity and safety. The market is telling us that there is going to be a nasty downturn and that risk tolerance has gone way down, so that high-beta stocks in biotech land have really gotten hurt. But at the same time, drug stocks were flat or slightly up for the day [on Monday] because drugs are much more resilient. The money is going someplace, and the question is where are health care funds putting it? Right now, they're putting their money into pharmaceuticals.

TSC: The fall is supposed to be the time of the year when biotech really shines and big gains are made. Should we forget about that happening now?

Loren: After the summer malaise, we were hoping to see a little rebound in September, given all the meetings going on. This really takes a lot of wind out of the sails. There is no question that it's going to be a hard market. As much as I'd like, or hope for, a roaring recovery very quickly, it's not realistic.

TSC: So we should expect more selling this week?

Loren: We still don't know. From our contacts in Europe, they were telling us that they were going to wait and see. What happens if they decide that they're a little uncomfortable with our market and start pulling out of the biotech area? Well, given the liquidity, that's a bad event. Most Europeans have not acted yet, and that's a big question mark.

TSC: And what about U.S. investors, especially fund managers who may have stayed out of the market Monday?

Loren: Every percentage point [the biotech sector] goes down, we hit someone's selling threshold. The other question is redemptions. If there are heavy redemptions, then, obviously, we're going to be in bad shape. But right now, from my standpoint and a lot of people we talk to, we're in unknown territory. We simply don't know what the average investor is going to do.

TSC: What about a recovery? Who will lead investors out?

Loren: Valuations are going to go down across the board, but I look for a recovery to be led by large-cap biotech stocks -- Amgen(AMGN Quote), Genentech(DNA Quote), Idec Pharmaceuticals(IDPH Quote) -- companies like these. The disadvantage on the large-cap biotech side is that they trade at very high multiples, even today. The advantage is that they are highly liquid vehicles.

They're more stable, they tend to have drugs on the market, and while we're convinced that [demand for] drugs does show some elasticity in a bad economy, it's not very elastic. It's not the same as a consumer deciding to buy a car or going on vacation -- most people will still take their drugs as scheduled.

TSC: Are there other signs biotech investors should key in on in the coming weeks?

Loren: There are still a lot of scientific conferences coming up. I'm not talking about investor conferences because those are getting pushed, but scientific conferences that are being delayed but will [still] go on. Also, look out for when the Food and Drug Administration starts to reschedule meetings. We want to see the system start to get back to normal and see data come out again. Also, we want to start seeing new-product launches -- there are some products that are getting ready to launch that reflect very well on the entire industry.