Biotech stocks finished out the month on a high note after a roller-coaster ride this year. Yet according to one top analyst, investors must trade the space carefully in 2016.
"It's really a stock picker year," RBC Capital Markets Michael Yee told the "Fast Money" traders last week.
Yee explained in his most recent note that plenty has changed in the biotech industry in 2015. The sector has evolved so rapidly that the public knows more about diseases, targets and designing better-targeted drugs than ever before.
However, while he remains "fundamentally positive" on secular innovation, he said overall outlook and expectations for biotech stocks have shifted. According to Yee, there are four major headwinds in the space that temper his view on stock performance in 2016.
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First, "there's a big money-flow change going on," he said. "After three years of gains of well over 30 percent a year in biotech, most fund managers have been overweight this sector for many years and I think there's a situation here where people are taking that overweight position and moving to a lot more equal weight position."
As investor interest is a crucial part of research and development for many biotech names, the possibility of a slowdown in growth increases in this type of environment.
Secondly, "I think as we're going into an election year I think people are going to be a little more cautious going into the political rhetoric that is going to pick up," Yee said. "I see biopharma stocks having a little bit of a tougher time in a political election year."
Skyrocketing drug prices have been the topic of many political debates and conversations involving Democratic presidential contender Hillary Clinton, Yee notes. Earlier this year, Clinton injected herself into the drug pricing controversy surrounding the medication Daraprim.
Whether the industry experiences pressure to lower prices or not, the general investor is going to shy away from investing in controversial stocks.
Third, Lee said that the technicals are sounding the alarm. "We've broken down on the Nasdaq biotechnology index (NBI) on the 200-, the 100- and the 50-day moving averages — I think it's going to take some time for us to grind back up," Yee said.
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Yet it remains to be seen if the August lows can continue to serve as support for 2016.
Lastly, Yee sees less chance of an earnings upside to the consensus models for each of the large-cap stocks versus previous years. In 2015, Amgen, Gilead, Biogen and Celgene all managed to trounce their own guidance by 10 to 50 percent. With less surprise catalysts in 2016, maintaining that momentum will be much harder.
Despite the potential for all these headwinds, Lee said there are three names that could break away from the pack in 2016: Biogen, Celgene and Vertex.
"Biogen has a number of catalysts, that stock has been beaten down all year and I think that stock starts to recover," said Yee. "Biogen has the most upside and downside potential with four big catalysts coming in the next 12-18 months."
Vertex and Celgene also have several catalysts on the horizon in 2016 for their drugs to treat cystic fibrosis and multiple myeloma, respectively. He says Celgene could start to move back up toward its highs.
"You need specific catalysts to move higher this year," said Yee.