AGNG - Crashing Biotech Stocks Bode Ill For The Broad Market

2023-03-11 04:42:25 ET

Summary

• Fed's aggressive rate hikes, plus SVB crisis, are a big worry right now.
• Behind the scenes, a (related) biotech stock crisis is also brewing.
• Market internals remain weak and demand caution going forward.

What do a major U.S. commercial bank failure and a weakening healthcare sector have in common? A lot more than you might think, as I’ll explain here. In this commentary, I’ll make the case that an alarmingly high amount of liquidation among recently launched biotech stocks could spill over into the broad market in the coming weeks.

Wednesday’s (March 8) front-page article in the Wall Street Journal spotlighted one of the Street's biggest concern right now—and a catalyst behind the latest market sell-off. “Fed Explores Faster Rate Increases” was the headline and it simultaneously underscored the market’s chief worry while also revealing the Fed’s remarkable shortsightedness in pursuing a tight money policy in order to slow the economy.

The latest bout of equity market weakness was kicked off when it was reported that Fed Chairman Powell is open to a half-point Fed funds increase in March in order to “help cool” the economy. Powell indicated he’s basing its planned rate hike this month in response to lingering inflation and recent U.S. employment gains.

Unsurprisingly, the market reacted to Powell’s latest statement with alarm, pushing an already vulnerable stock market into further disarray. The prospect of even higher rates hit the financial sector particularly hard, with bank stocks bearing the brunt of the selling pressure. The KBW Nasdaq Bank Index (BKX) was down as much as 14% in the last three days in a show of just how much fear permeates the rate-sensitive banking industry.

Participants are also anxious over the turmoil at startup lender SVB Financial Group (SIVB) - the parent of Silicon Valley Bank—which was closed by banking regulators on Friday. According to Reuters, the SVB fiasco is the largest FDIC-insured bank failure since the 2008 credit crash. The recent collapse of SVB’s stock price has raised the prospect of another credit crisis, further fueling selling pressure.

SVB, which is Silicon Valley’s biggest bank based on local deposits and the 16 ^th largest in the U.S., was hurt by higher interest rates as, in the words of the Wall Street Journal , it “announced a big loss on its bondholdings,” prompting a sell-off of its shares. Analysts point to the Fed’s rate hikes being the specific reason for the erosion in SVB’s $21 billion bond portfolio value (which it was forced to sell at a $1.8 billion loss).

There’s more to the story behind SVB than just rising rates and bond losses, however. The tech lender was also known as a major banker with healthcare sector companies. According to Silicon Valley Bank’s website , 44% of U.S. venture-backed technology and healthcare IPOs bank with SVB.

Why is this significant, you ask? Because as I pointed out in my previous article, major weakness in the healthcare sector—particularly among a large number of recently launched biotech firms—have lately dominated the growing number of new 52-week lows on the Nasdaq. And that, in my view, is a key reason for the broad market’s weakness.

Hitting upon this theme was a Barron’s article that noted SVB’s crisis “is setting off deep worries in the biotech sector, which has close ties to the bank.” The article further observed that biotech companies’ “access to their own cash” and “the ability of early-stage healthcare companies to raise money” were major concerns among investors, who fear a ripple effect across the market as a result of the demise of the bank “most closely tied to the biotech industry.” The following graph of the iShares Biotechnology ETF ( IBB ) shows the extent of the selling pressure of recent days.

The internal weakness that has characterized biopharma stocks in the last few weeks can also be seen in the following chart. This one shows the 4-week momentum of the new 52-week highs and lows among Russell 2000 small cap stocks (which includes many healthcare sector names). As you can see, the indicator is in collapse which suggests the near-term path of least resistance for small cap stocks in general (including biotechs more specifically) is down.

On a more positive note, after Friday’s SVB-inspired debacle, the daily trend of biotechs dominating the Nasdaq 52-week lows came to an abrupt halt. In its place, financial and real estate stocks comprised the biggest share of new lows as SVB’s collapse has already rippled across the broader financial sector, sparking fresh crisis fears. (There were still, however, a fairly high number of therapeutic-type stocks on the new lows list.)

While it’s unlikely a final low in the biotech space has been seen, it’s possible the brunt of the selling pressure will shift from healthcare to banks and other rate-sensitive equities. At any rate, internal selling pressure as reflected by the new 52-week lows list on both the NYSE and Nasdaq exchanges is still quite high and indicative of potential danger in the coming days.

Consequently, I reiterate my recommendation for conservative investors to hold off on initiating new long positions until the selling pressure dries up.

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