Street Talk: Cautious Optimism: the Watchwords for Volatile Sector

As I've been saying, 2007 is turning out to be a strange year for investors. Going back to February 26, after the Big Dip when the stock market tanked some 500 points, before rebounding, the Standard & Poor's Index had been down about one percent through mid-March. But it has bounced back in a big way, rising from around 1,375 to 1,515 through the end of May. The Dow Jones Industrial Index is climbing, too; it reached a high of 13,500 on May 24. The Biotech stock indexes followed suit, falling slightly more to 1.12%, according to the Morgan Stanley Biotech Index, before bouncing back in April.

Brian O'Connell

Which leads me to my topic for today—my favorite biotech electronic trading fund (ETF)—BBH Holdrs.* This fund has meandered so far in 2007, down 10 points or so since the late February stock market debacle, but up 1.9% (through late May, 2007) and is up over 7% over the last year. The fund shot up in April, rising 6.3% as its "big guns" rose accordingly, thanks to a stiff tailwind from the rest of the broadening stock market and some welcome sales revenue and clinical trial news.

For instance, Amgen saw its stock climb 5% after reports that its Aranesp anemia drug did not contribute to the deaths of patients in a Phase 3 lung cancer trial. BBH also benefited from Gilead Sciences, which saw its first quarter earnings spike upward by 55% from the year before, adding $4 to its stock price.

Immediately after investors got hold of both these bits of good news, shares of BBH climbed almost 4% in one week alone, to $186 (a 2% rise in the value of the overall portfolio).

Some Wall Street gurus jokingly refer to BBH as the Amgen–Genentech fund, and perhaps with good reason. Genentech, Amgen, and Gilead Sciences make up most of the fund, along with Genzyme, Medimmune, and others. That's like having Manny Ramirez and Chipper Jones anchoring your company's beer league softball team.

BBH was hardly alone in suffering a setback in February and March; the AMEX biotech index and iShares Nasdaq Biotech Index fell in lockstep with BBH and the rest of the equities market. Patent protection was one sour issue impacting life sciences companies—more than 70 drugs will lose their patent protection in the next few years, including Pfizer's cholesterol reducer Lipitor and Bristol-Myers Squibb's blood thinner Plavix. Business Week estimates that pharmaceutical companies could lose up to $100 million in lost sales by 2011.

But there is good news in other areas, like quarterly earnings. Clinical drug trials, and an overall stock market that continues to grow, despite taking its fair share of lumps in the housing and oil and energy sectors, have trumped the potentially bad news, or at least pushed such news to the shadows for the time being.

But that's the nature of the biopharmaceutical market, isn't it? Investors have to expect volatility here and they get it. Check out Amgen. By and large, most big company stocks don't get the yo-yo treatment. Usually stocks like Microsoft, Proctor & Gamble, or Bank of America are pretty stable. Not so the biotech giants. In the last year alone, Amgen has seen its stocks price trampoline between $52 and $77 per share, as a regular stream of clinical trial news hits the street and drives investors to feverishly buy and sell, accordingly. In the long run Amgen has come out ahead (Table 1). In the short-term, not always. But that's life in the biotech fast lane. Warren Buffet told his Berkshire-Hathaway shareholders at the company's infamous annual meeting in Omaha last month, he prefers stocks with "lumpy" returns of 15% or so to more steady ones that drift along at 10–12%. In other words, he'll take a little volatility to gain some better numbers.

Table 1. Big biotech stocks and how they've done

Now, don't get me wrong. Buffet has taken great pains to say in the past that investments in BBH or any other life sciences stock or funds is akin to root canal or suffering through 10 minutes of "The View." But when he makes comments like that to his own shareholders, I have to think his cold demeanor toward biopharmaceutical stocks is thawing a bit, if he's willing absorb some lumps and bumps to get a better return.

Like Warren Buffet, my feeling is that you can't get too excited about short-term ups and downs. That's especially true of biotech, which doesn't play by the same rules that most industries do when it comes to stock performance. In the biotech world, success is defined by clinical successes and failures—not by shock waves resulting from outside-the-industry market downturns like we saw in January, February, and March. Companies that comprise the BBH—like Amgen and Genentech, are insulated from such external pressures, primarily as a result of their well-stocked pipelines and deep reservoirs of cash and R&D talent.

The big picture continues to brighten. We're also seeing an uptick in biotech investing from the venture capital community—a good sign that biotech can indeed march out of lockstep with the rest of the stock market and rise even higher than the broader markets. In addition, the biotech industry overall should benefit from ongoing pressure from Congress to lower drug prices. True, such pressures could slow the progress of some of the Big Pharma boys, but that will only level the playing field for the rest of the sector.

Besides, stalwarts like Amgen and Genentech should thrive just the same; both have strong pipelines and high demand for their products. Sales at both companies have been strong and should only grow stronger.

That should bode well for favorites like BBH, even in a volatile biotech environment. I've said it once and I'll say it again: BBH is chock full of companies whose products wind up in pharmacy prescription bins and stacked up on shelves along store aisles. That fact isn't going to change anytime soon and that's good news for BBH investors.

Consequently, my view of BBH is that it's a good long-term play. Companies like Genentech, which is heavily involved in the human genome project, and Gilead Sciences, which is working on new pharma drugs for HIV/AIDs and other diseases, could revolutionize healthcare.

With Genentech and Amgen swinging big bats at the heart of the order, I believe that the BBH fund continues to be a great way to play the biotech sector—and should be for the foreseeable future.

*I hold no position in BBH.

Celebrity author and business/finance commentator for CNN and Fox News, Brian O'Connell has written for The Wall Street Journal and Newsweek: Doylestown, PA, 215.230-3711, brian.oco@verizon.net