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Cramer: China could cause biotech stocks to plunge

Cramer: China & biotech - it's complicated

Jim Cramer recently had an investor ask him what biotechs, old pharmaceuticals and new pharma have to do with what is happening with China. And while the question may seem quite simple, it is actually incredibly complicated to answer.

"On the one hand, biotech and pharma should have nothing to do with China. But on the other hand, they are deeply intertwined. And that intersection is both treacherous and full of opportunity," the "Mad Money" host said. (Tweet This)

Cramer noted that the fortunes in biotech and big pharma have very little to do with the fortunes in China. Something is clearly very rotten in China, but it isn't so bad that it could actually hurt sales of a big company like Pfizer or Celgene. People will get sick, and they will still take medicine.

So, on the surface it may appear that any weakness in China shouldn't affect these stocks. But that is not correct, and Cramer is worried that many people are making that assumption right now as they put money to work in these stocks.

The first complication has to do with the mechanics of money management. If China's economy is really headed downhill, then it could cause a worldwide recession. Many of the companies that provide raw materials to China will incur stressed balance sheets, and some will default.

On the one hand, biotech and pharma should have nothing to do with China. But on the other hand, they are deeply intertwined. And that intersection is both treacherous and full of opportunity
Jim Cramer
Rafe Swan | Getty Images

Thus, if a money manager who has a choice between stocks and bonds thinks a worldwide recession is possible, the manager will run from equities into bonds. Both biotech and old-line pharma stocks are in indices that would get pulled down from that.

Plus, in times of turmoil, speculation stocks tend to be under stress, along with the investors who love to trade speculation stocks. So, these speculative shareholders could sell off the biotech stocks from underneath them because the investor didn't have enough capital to meet margin calls.

In other words, the profits of a stock like Regeneron won't get hurt by China. But the stock could still go down if there is a worldwide selloff in all stocks, and then it could go down further if speculative investors can't cover the borrowed money they used to buy Regeneron.

A lousy shareholder base mixed with portfolio managers who want to take less risk doesn't exactly add up to biotech stocks that are brimming with earnings to fall back on.

"I like to think of biotech stocks as black-double-diamond runs on the slopes: they're fabulous to ski on when the power is perfect and the sky is blue, but foolhardy to go down on when it's frozen, stormy and icy," Cramer said. (Tweet This)

Big pharma stocks with dividend protection aren't a safe-haven from China, either.

Right now the U.S. is perceived as the strongest nation on Earth, and it is a magnet for money from all over the world. A strong dollar is great if you're buying goods from overseas, but it's terrible if you're selling goods overseas in a weaker currency and then have to translate it back into the dollar.

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One reason why American pharmaceutical companies do so well is because they have huge international sales. But when the dollar gets stronger, these drug companies make less money than the analysts expect. That means estimates will get cut for big pharma when the dollar goes higher.

Ultimately, neither biotech nor big pharma stocks are truly safe from China.

"On an up day like this one, remember that if we get real worldwide turmoil, you have to let it bring down the stocks of companies you like to levels where good things can happen," Cramer added.

Just keep in mind that no matter how safe these companies seem, their stocks could come down on a global recession. And once the smoke clears, they will finally bounce to produce the steady gains investors love.

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