Editor's Note: Adam Feuerstein's columns run exclusively on RealMoney.com; this is a special free look at his column. For a free trial subscription to RealMoney.com, please click here. This article has been updated from its original publication date of June 9 on RealMoney.


The foundation of the recent biotech recovery was laid last September, when President Bush picked adviser Mark McClellan to lead the rudderless Food and Drug Administration. From the moment of his appointment, McClellan, a doctor and noted health care economist, made it clear that one of his top priorities would be to reinvigorate the regulatory agency and speed up the approval of new drugs.

At the time, few, if anyone, could've predicted just what an impact McClellan's words would have on the biotech sector today, which is the midst of a heart-stopping rally.

The Amex Biotech Index ( BTK) is now up about 38% for the year. (It was up more than 50% recently.) The broader market has also rallied, of course, but the biotech sector has been leading the way.


Follow the Leader
The Amex Biotech Index surges ahead in 2003


Talk about a turnaround. The Amex Biotech Index fell 39% in 2002 -- its second consecutive year of losses -- so when the bell rang to begin trading in 2003, few investors were in the mood to predict good times ahead.

It would be foolish to ascribe 100% of the biotech recovery to McClellan's leadership at the FDA; after all, there's just so much one guy can do. But a spate of drug approvals quickly left Wall Street with the impression that the regulatory agency -- once seen as a hindrance -- was now ready to help.
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"In hindsight, I think the first clue that we had a friendlier FDA was the Dec. 24 approval of Restasis," says David Chan of the Jennison Health Sciences Fund (formerly known as the Prudential Life Sciences Fund). Restasis is a drug developed by Allergan ( AGN) to treat chronic dry eye disease, but the data supporting the company's filing were not entirely conclusive, Chan says, and that could've tripped it up at the FDA. It didn't.

After that, the FDA approved drugs from Genzyme General ( GENZ), AstraZeneca ( AZN) and Millennium Pharmaceuticals ( MLNM), and it did so with alacrity. Investors, of course, jumped all over this news, concluding that the FDA would approve just about anything. Naturally, shares in biotech firms with drugs in front of the FDA have taken off.

For example, take a gander at the chart for CV Therapeutics ( CVTX). Six months ago, this was a radioactive stock, because everyone was sure the FDA would reject its angina drug, Ranolazine. Today's conventional wisdom goes more like this: Puh-leeze, the FDA is a bunch of pushovers, right?

As if biotech needed a second wind to propel this rally, it got one in spades at the American Society of Clinical Oncology's annual meeting, better known as the Super Bowl of cancer research confabs. You've no doubt heard about the big winners: Genentech ( DNA) and ImClone Systems ( IMCLE). The whole meeting was a huge positive for biotechs, unlike the 2002 gathering, which, by comparison, had all the laughs of a funeral procession.

"At last year's ASCO, investors were worried about their investments and the future of biotech," says SG Cowen biotech analyst Yaron Werber. "At this year's ASCO, we finally saw clear indication that biotech drugs, and not Big Pharma, are the drugs of the future."

All Good Things Come to an End

So, how long does this biotech rally last? So far, every attempt to call a top has been wrong. A lot of professional biotech traders thought there'd be significant post-ASCO selling, just like in years past. Wrong.

Chan believes big mutual fund buyers are coming back to biotech in a big way to satiate their jones for growth stocks. For a long time, the sector's biggest name, Amgen ( AMGN), was the only must-own stock, but now, fund managers have to own Genentech, too, he says, adding that this kind of muscle moving into the biotech sector is bound to keep the rally going. (It might just get Genentech to the $100 price target recently set by UBS Warburg's biotech analyst.)

Of course, you'd expect to hear this kind of happy talk from an investor who can only go long. But there are fundamental reasons to support a continued biotech rally, including expected strong second-quarter earnings and more drugs on the FDA docket awaiting approval. Tuesday, the FDA approved FluMist from MedImmune ( MEDI); approvals for the asthma drug Xolair from Genentech and the antibiotic Cidecin from Cubist Pharmaceuticals ( CBST) could come by week's end. If that's not enough, plenty of clinical data will be released this summer, too. In the past, this would be cause for concern, but these days it's "don't worry, be happy" time.
New Luster
CV Therapeutics makes a comeback

But biotech firms have been taking advantage of the rally to raise a ton of cash. Well over $2 billion in new convertible debt and equity offerings at last count have been pushed through in recent weeks, flooding the market with a lot more supply and likely contributing to a cooling-off in the sector.

And biotech investors are also acting as though it's 1999 all over again and all those painful lessons of the past two years were but a bad dream. You think the recent move in the sector is fantastic? How easy it is to forget that as late as September 2000, the Amex Biotech Index was above 800? For every sensible biotech investor who's hedging his longs with options to limit potential losses, there are countless newbie biotech investors who are buying blindly, as if the party will never end.

Need proof? Just look at the frothiness found among small-cap biotechs. These ultra-risky stocks have surged far more than the big-cap names. When dubious stocks double on the issuance of a questionable press release, you know that momentum investors and daytraders are chasing beta, not fundamentals. Yet someone, somewhere will be left holding the bag when the mania ends. Someone always loses.

Says one biotech hedge-fund manager who has been through enough boom-and-bust cycles to know, "This is going to end badly for a lot of people. The only question is when."


Editor's Note: Interested in learning more about biotech? Attend an interactive chat Wednesday, June 25 with RealMoney columnist Adam Feuerstein to learn the five things you need to know before buying a biotech stock -- and also to ask questions of Adam. Tune in to chat about this hot sector! Click here for more information and to sign up.

Adam Feuerstein writes regularly for RealMoney.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback.

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