24th Jan 2021
Looking ahead to 2021, the future for small-cap biotech stocks may be determined by trends that affect both the pharma industry and smaller companies in general. The latter have a record of improved performance in the year following a US presidential election, due to renewed focus on domestic issues. Small caps could be more susceptible to movements in the local US economy, as opposed to large caps whose exposure to global markets is greater. While the Russell 200, the index of US small-cap companies was down in 2020, affected by the US recession and threat of Covid-19, its average return in each year that followed a presidential election since 1980 is around 15%, 4% better than the average for large-cap shares.
Small-cap biotech firms have particular cause for confidence going into 2021. They reached 40% above their 200-DMA (the index’s average closing price over the last 200 days, an indicator of price trend) at the end of 2020. Mergers and acquisitions of small-cap biotech companies were numerous and lucrative over the year. Examples include AZ acquiring Alexion for £39bn, J&J buying Memoenta for $6.5bn and Gilead taking over Immunomedics for $21bn.
The factors supporting this trend seem likely to continue into 2021. Firstly the research and development side of pharma is relatively insulated from changes in consumer demand or short term economic cycles. Indeed The FDA’s CDER approved 53 new medicines in 2020, despite the bulk of its resources going towards fighting Covid. Demand for biotech innovation persists even in economic downturn, evident in ongoing M&A activity and the companies such as BioDelivery and Exelixis waiting for market recognition of their strong innovation, business models and market potential. Secondly, massive financial injection from the Federal Reserve combined with near zero interest rates, creates market conditions where investors are looking for yield opportunities. In this context, with the strongly positive public sentiment towards science and biotech enhanced by its frontline role in the fight against Covid, this sector could be an attractive option for those seeking lucrative risk/reward arrangements.
Given small caps’ greater exposure to the domestic economy and uncertainty about where the next drug breakthrough may come from, a diversified exposure to the biotech sphere is an important principle of investing in this sector. ETFs have a particular role, therefore, in offering next generation sector investing coverage while not relying on any one particular company to succeed. Overall markers for the sector were very strong in 2020: according to preliminary data from Pitchbook, over $26bn of venture funding went into US-based biotech firms in 2020, and biotech IPOs hit an all-time high for both volume and deal activity, raking in proceeds of over $14bn across 74 deals (not including SPACs!). Moving into 2021, small-caps have most to gain from such deals, as large caps compete with investors to benefit from the innovative biotech products developed by the up and coming companies.
1“Small stocks may thrive in 2021 — no matter who wins the election,” Paul R. La Monica, CNN Business, September 18, 2020. https://edition.cnn.com/2020/09/17/investing/small-caps-election/index.html
2“Themes To Watch And Technical Stock Market Outlook,” Randy Watts, December 30, 2020. https://www.forbes.com/sites/randywatts/2021/12/30/2021-themes-to-watch-and-technical-stock-market-outlook/?sh=637ba1b01a35
3“The Biotech Paradox Of 2020: A Year In Review,” Bruce Booth, January 4, 2021. https://www.forbes.com/sites/brucebooth/2021/01/04/the-biotech-paradox-of-2020-a-year-in-review/?sh=32151efc43b3
4“The Biotech Paradox Of 2020: A Year In Review,” Bruce Booth, January 4, 2021. https://www.forbes.com/sites/brucebooth/2021/01/04/the-biotech-paradox-of-2020-a-year-in-review/?sh=32151efc43b3
5“Best Stocks to Buy in 2021 by Sector,” Fatma Khaled, Dec 30, 2020. https://www.thestreet.com/investing/best-stocks-to-buy-in-2021-by-sector