Biotech Stocks: What Could Spoil The Rally In 2015?

Disclosure: I own shares of ABBV

Biotech stocks staged a big rally in 2014, outperforming the overall market. The iSharesNasdaq Biotechnology (NASDAQ:IBB) have gained close to 30% for the year compared to 12.5% gain for the S&P500 and 14% gain for the NASDAQ market.

The low interest rate environment and a string of new drug approvals have been driving the biotechnology rally.

Will the rally continue in 2015?

We cannot say for sure. What we can say is that certain favorable factors (e.g. healthcare policies, demographics and new product approvals) will provide tailwind for biotechnology stocks. At the same time, the industry will face two threats that may end up slowing down or even derailing the rally.

First is a strong US economy — GDP is growing at 5%, according to the latest government data. That could force the Federal Reserve to raise interest rates sooner rather than later.  And that could spell trouble for the sector, as it will signal an end tocheap margin-borrowed money, which has been propelling shares of some revenueless biotech companies into the stratosphere.

Then comes approval of new drugs, which creates competition for blockbuster drugs – which is expected to undermine pricing power and profitability in the industry.

Gilead, for example, commands a 58.37% operating margin!

Source: finance.yahoo.com

AbbVie's all-oral treatment for hepatitis C, which gained FDA approval last week, is a case in point. AbbVie’s new drug would cost $83,319 for a typical 12-week plan, a bit below its huge selling competitor Sovaldi from Gilead Sciences.

That prompted Express Scripts to cover AbbVie’s drug and drop Gilead’s treatment. And Wall Street took notice, sending Gilead’s shares sharply lower and AbbVie’s stock higher.

Nonetheless, AbbVie’s gains were tapered, and eventually turned into losses, as competition ultimately hurts both companies.

While biotechnology will continue to provide new medicines that save lives and enrich investors who finance the development of these medicines, the industry cannot escape from the macroeconomic and microeconomic conditions that make the dollars to riches past bumpy, to say the least. Hype should never be a substitute for due diligence.