Politics Trigger Biotech ETF Crash

Negative news flow and a broad sell-off in U.S. stock markets sent biotechnology exchange-traded funds plummeting for a fourth-straight session on Monday. The iShares Nasdaq Biotechnology ETF (IBB | A-46) lost more than 6.3 percent on the day after having shed nearly 5 percent on Friday.

That brings the total loss in the fund since the July all-time highs to 27.5 percent. IBB is now essentially back to where it briefly fell during the Aug. 24 "mini flash crash."

IBB Price

Negative News Flow

The problems for biotech stocks started last week when news broke that a little-known company called Turing Pharmaceuticals increased the price for a specialty drug called Daraprim. The markup—from $13.50 to $750 overnight—caught the attention of the New York Times, which ran a scathing story in response.

Soon, media outlets and pundits around the world were expressing outrage over Turing Pharmaceutical's move in particular, and the high cost of drugs in general. The news even caught the ire of Democratic presidential candidate Hillary Clinton, who referenced the New York Times article when she tweeted that "price gouging...in the specialty drug market is outrageous."

Clinton's tweet set off a cascade of selling in biotech stocks, which lasted throughout the week.

Adding fuel to the fire on Monday was news that 18 Democratic lawmakers in the House of Representatives were pushing to subpoena Valeant Pharmaceuticals for documents related to big price hikes on two drugs it had recently acquired.

Unsurprisingly, shares of Valeant were hammered on the day, losing about 16.5 percent on Monday alone. As a NYSE-listed stock, Valeant isn't included in IBB, which holds only Nasdaq-listed securities. Moreover, Valeant is considered a traditional pharmaceutical company rather than a biotech company, and it's headquartered in Canada; thus, it would be excluded from IBB on those grounds as well.

Nevertheless, Valeant's woes were distinctly felt broadly across the health care sector. The Health Care Select SPDR (XLV | A-93) dropped 3.9 percent on Monday, bringing its decline from the August record highs to 16.8 percent.

Still Outperforming

It's important to put the sell-off in health care and biotech in perspective. Up until August, the sectors were among the best-performing in the U.S. stock market, with IBB and XLV up 31 and 13.5 percent, respectively, on a year-to-date basis at their highs.

Now the two are down 4 and 5 percent, respectively, but that's still better than the negative 7.2 percent total return for the SPDR S&P 500 (SPY | A-99), the ETF that tracks the S&P 500.

YTD Returns For IBB, XLV, SPY

From a longer-term perspective, the numbers are even more stark. During the past five years, IBB surged 237 percent and XLV gained 128.8 percent, handily outpacing SPY's 91.5 percent return in the same period.

Five-Year Returns For IBB, XLV, SPY

Potential Pricing Pressures
That said, there's always the possibility that this could be just the start of a period of poor returns for a sector that has beaten the broader stock market for many years.

If Democratic lawmakers get their way, drug companies' pricing power and profits could suffer. Under Hillary Clinton's proposal outlined last week, out-of-pocket drug costs for patients with serious medical conditions would be capped at $250 per month.

Additionally, Clinton's plan calls for reducing tax breaks for drug company advertising, requiring firms to invest a certain percentage of their revenues in research and development, reducing the exclusivity period for biologic drugs, speeding up the approval process for lower-cost generic drugs, and allowing cheaper drugs to be imported from overseas.

Buying Opportunity?

Whether such a proposal could muster enough support to pass through the Republican-controlled Congress, and whether Clinton even gets elected, are still open questions. In the end, nothing may change and drug companies could retain their immense pricing power.

If that's the case, the recent pullback could end up being a rare buying opportunity for long-term investors. Supporting that view is the bullish outlook for health care in the U.S. generally. Demographic trends and increased spending from Obamacare are likely to bolster demand for health care, biotech and pharmaceuticals going forward.

In the end, investors must weigh these rosy fundamentals with the risk of regulations and more negative news flow. With election season in full swing, the political rhetoric over the hot-button issue of drug prices is unlikely to die down anytime soon.

Contact Sumit Roy [email protected].