The people who study stock charts for a living noticed around mid-June that a closely watched drug-industry index started on an uncomfortable downward path while a broader index of market activity maintained a steady upward pace.
And although the Amex Pharmaceutical Index has made some recovery in recent weeks -- as the
index also moved onward and upward -- some investors are worried. Is there a fundamental change in the ultimate defensive growth stocks, whose companies provide a haven for investors in bad economic times?
Not necessarily, experts say. The recent slip in the drug stock index doesn't represent a fundamental shift, said Pat Dorsey, director of stock analysis for Morningstar. "It's not like the tectonic shift in telephone or utility stocks," he said.
However, investors in big drug companies will have to get used to slower growth based on the industry's economics -- such as the greater influence of generic drug companies -- and politics. "There's a more popular recognition of the large margins they make, and that makes them an easy target for political potshots," Dorsey said.
"The next 10 years will not be as fast growing as the last 10 years," Dorsey noted. "But at their
market multiples, they don't have to shoot the lights out
with growth. When you get a big upturn in the economy and
stocks are shooting to the moon, these drug stocks are reasonably priced."
Al Goldman, chief market strategist for A.G. Edwards & Co. in St. Louis, pointed out that the Amex drug index gained about 25% from mid-March before starting its slide in late June. Then, the index fell about 15% before it turned upward in late August. "I think it was an emotional change -- not a fundamental change," he said.
As of the end of last week, a $1,000 investment made at the beginning of the year in the Amex index of 15 pharmaceutical companies had climbed back into positive territory. It was worth $1,070. The same investment in the S&P 500 index was now worth $1,180. And that $1,000 bet placed on the Amex Biotechnology index had climbed to $1,470.
The biotech index -- in which 15 of 17 stocks have risen this year -- essentially matched the other indexes step for step until late April -- and then took off.
The biggest winners in the biotech index are
( DNA) (up 165% this year) and
( MLNM) (up 103%). The big loser in the index is
The Amex Pharmaceuticals Index has had six losers and nine winners this year. The biggest winners are a generic and specialty drug company,
( IVX), (up 65%) and a biotech company,
, (up 42%).
Goldman said the drug index performance this year could have been linked to many things. Health care stocks are sensitive to proposed changes in government policies -- so the uncertainty about how Congress will vote on competing Medicare drug coverage proposals certainly played on investors' decisions. Add the gains of cyclical stocks amidst an improving economy, mix in the recent tech stock advances (including biotechnology) and you have the formula for drug stock investors deciding to take some profits.
Sam Stovall, the chief investment strategist for Standard & Poor's, said major pharmaceutical stocks have been in a "downward trend for some time" as investors realize that big-selling drugs are losing -- or will soon lose -- patent protection. There's also a realization that some big companies' research pipelines "are not that great," Stovall said. "For major pharmaceutical companies, the pipeline is the key."
Another reason for the weak drug index performance is "company-specific problems like Schering-Plough," Stovall said.
( SGP) is down 25% for the year. Several other giants --
Johnson & Johnson
(down 6%) and
(down 5%) -- have helped depress the drug index.
Medical Devices Gain Steam
Stovall said the best place for a medical investor right now is biotechnology or medical devices. Goldman likes biotechnology, too, because he believes the latest round of biotech stock news is more associated with real or projected earnings rather than with the heavy doses of scientific promises that fueled the biotech boom of the late 1990s.
Biotech requires a lot of attention, though. Sure, biotech is hot now. And if you had plunked down $1,000 on the Amex Pharmaceutical, Amex Biotechnology and S&P 500 indexes at the end of August 1993, your biotech bet would have been worth just under $4,000 by the end of August 2003. During this period, your Amex Pharmaceutical Index account would have reached $3,700; and your S&P 500 Index investment would have risen to $2,170.
But let's say you made the same three $1,000 choices in mid-September 2000. If you had panicked and bailed out by mid-September 2002, your biotechnology investment would have shriveled to $460 and your broader market investment would be worth only $610. Your defensive bet on pharmaceuticals would have been worth $760.
If you had the courage to hang on, by mid-September 2003 your biotech index bet would have been a slightly smaller disaster -- worth only $650 -- and your S&P 500 index investment wouldn't be much better at $700. Your drug index investment would be worth $840.
If you can't tolerate so much biotech volatility, try medical device companies, said Morningstar's Dorsey. "Devices like orthopedic products are evolutionary rather than revolutionary," he said. "And there's more product loyalty because changing devices requires doctors to retrain."
S&P's medical equipment company index is up 22% for the year. Among the 11 companies in the index are
( GDT) (up 55%),
St. Jude Medical
(up 46%) and