WHITEFISH, MT / July 30, 2014 / The July 15 U.S. Federal Reserve report on monetary policy touched off a barrage of barely polite and not very muted commentary from one end of the web to the other this past week with 32 simple words: "Equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched, with ratios of prices to forward earnings remaining high relative to historical norms." The release of the report to Congress coincided with the start of Federal Reserve Chairwoman Janet Yellen's testimony before a Congressional committee. NBI, the Nasdaq Biotechnology Index, slumped from around 2,700 on Tuesday to a low of 2,536 on Thursday, a 6% nosedive, before paring the losses with an up day on Friday. Of the 120 companies in the NBI, 101 closed in the red last week, including Ligand Pharma (NASDAQ: LGND) shedding 19.4% and Raptor Pharma (NASDAQ: RPTP) falling 18.7%.
SOCL, the Global X Social Media ETF, reacted similarly, shedding about 4% before mitigating the damage on Friday.
The dustup prompted a Forbes writer to reprint one market figure's open letter to Fed Chair Yellen. The letter, sent to clients by Mark Schoenebaum, lead health care analyst at International Strategy & Investment Group, quietly but firmly takes the Fed to task for- at best- misinterpreting data, saying, in part, "I just gathered biotech price to earnings ratios back to 1993 using Russell 1000 data, and my data show that the current ratio is roughly in-line with the historical median and is approximately 80% below the peak. Please tell me what I’m missing, Dr. Yellen."
A Wall Street Journal headline blared, "What Yellen Did to the Markets, in Three Charts". Online Barron's called the Fed statement an "unusual dropkick to two stock-market sectors..." Further, wrote Barron's Brendan Conway, "Sounds like the monetary-policy equivalent of terrorist-whacking drones in place of full-scale invasions. Is that a good idea? You can’t blame biotech investors, especially, for feeling bruised."
Conway was explaining, or trying to explain, new Fed strategy, which he said was an oblique way of avoiding Fed policy tightening, i.e., by targeting specific market sectors. However targeting entire sectors without providing a corresponding analytical rationale that might also enable some discrimination at the individual company level seems like an ill-considered gesture.
Achillion Pharmaceuticals (NASDAQ: ACHN) had seen shares tear ahead in June with the FDA lifting a clinical hold on its study of experimental hepatitis C drug sovaprevir and speculation the company may be an acquisition target. Momentum looked to be building again after the run, but was hamstringed for a loss of nearly 11 percent the week of the Fed comments. Was Achillion’s valuation "stretched" with an $800 million spike? That’s a tough question. Maybe the central bank has more insight on what a new hep C treatment is worth.
While the NBI components fell, the Fed comments resonated across most other small Nasdaq-listed biotechs as well. Athersys (NASDAQ: ATHX) illustrates the effect of the Fed statement in stark terms, as Tuesday wrought the start of a 12% decline in shares by Thursday’s close on nothing more than an industry stampede prodded by Fed meddling. In this case, with $45 million in cash on hand at the end of first quarter, the $17 million drop in valuation, means that the company’s technology in several clinical trials is worth less than $100 million. That hardly seems "stretched."
CTI BioPharma (NASDAQ: CTIC) has performed well in 2014, but was trading well off a January high of $4.25, even with the recent announcement of completing recruitment in a pivotal Phase 3 trial of pacritinib for myelofibrosis. Technically speaking, the chart was at a key point with trying to hold the 200 day moving average, when the Fed report was released, sending the price down by 11.7% on the week and under the closely watch price indicator. Two weeks later, the stock is still trading below the 200 DMA. It’s probably fair to say that the Fed doesn’t consider technical components on individual stocks, although plenty of traders certainly do when making investment decisions.
The list can go on and on, with some companies regaining the lost ground, while others have not.
What this raises in the minds of market participants is the question of whether the Federal Reserve ought to be in the dubious business of playing market analyst in such a public way. As one pundit privately put it to SECFilings.com, "Let's turn this around- how about if the Fed started telling everybody that some sector is undervalued? How would that look?"
It's a telling point. Though part of the Fed's legally designated role is supposed to be to maintain the stability of the financial system, it's a real stretch for it to take out its ruler and start whacking the fingers of individual investors in more narrowly defined market sectors. And worse, it did so this time against much-needed research entities, on whom lives depend. Without adequate investor funding, innovative research is deferred or even cancelled, resulting in corresponding delays of the development of safer and more effective medicines.
Moreover, in its so-called valuations, the Fed took no account of the impact on rising valuations underpinned by an improved regulatory climate within the Food and Drug Administration that is supporting innovation. Amongst other initiatives, not only has the FDA broadened the accelerated approval pathway and implemented the new "Breakthrough Therapy" designation to expedite broad development of drugs that meet areas of great unmet medical need, but President Obama’s advisors have suggested changes to streamline clinical trials related to developing new antibiotics. Point being, regulators see the need for a raft of innovation in the biotech space, which supports increased value of companies as the time and expense of drug development is meaningfully reduced. Some may postulate that this is the "new way of the Fed," but officials at the central bank really ought to be more cautious in their comments, whether they think the words are benign or not. The potential harm to shareholders, companies and even patients is real, and is likely to spur a backlash.
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SOURCE: Emerging Growth LLC