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Thursday, December 8, 2016

Did Congress Just Kick Off A New Bio Bubble?

On December 7, 2016, the U.S. Senate passed the 21st Century Cures Act. President Obama said he plans to sign the bill into law as soon as it hits his desk. The Act, which is designed to facilitate FDA approval of new drugs and medical devices, is a major win for the Pharmaceutical and Medical Device industry, and its supporters such as PhRMA and AdvaMed. Industry spokespersons praise the Act as a way bring about more innovation and get treatments to patients faster.

The bill passed by an overwhelming 94-5 and 326-24 majority. The measure would benefit people with mental illness and chronic diseases, biomedical researchers, pregnant women, hospitals, children with diabetes, people addicted to opioid drugs, children who are bullied, and those who are gravely ill (source: NY Times). And importantly, the measure includes no provisions to rein in prescription drug prices.

What's It Means

The 21st Century Cures Act is designed to enhance current FDA programs and allow for a quicker path for breakthrough medical technologies for patients with life-threatening or irreversibly debilitating diseases or conditions, and limited alternative treatment options. The Act directs the U.S. FDA to make decisions based on the use of “real world evidence” for approval of new indications for FDA-approved drugs. It's a major win for existing drug companies with approved products already on the market and for smaller biopharma companies looking to reformulate off-patent medications for new uses.

The use of observational studies, patient input, anecdotal data, and other retrospective research greatly reduces the cost and time to market compared to conducting large randomized clinical trials. Phase 3 trials will still be necessary for the majority of industry players, but I expect these trials will get smaller and the endpoints to become more subjective. This should increase the odds of success as the FDA may focus less on objective measures and placebo-controlled statistical analysis plans.

A big winner is the U.S. National Institutes of Health (NIH). The NIH research budget will increase $4.8 billion once the bill is signed into law. The legislation earmarks $1.6 billion to create suicide-prevention programs and to improve mental health services for children. It also allocates $1 billion in state grants for the opioid epidemic and seeks to strengthen laws that require the government and insurers to treat mental illness like other diseases (source: PBS). The landmark legislation provides funding for three signature Obama administration research programs, over the next 10 years: the “Cancer Moonshot”, the BRAIN Initiative, and the Precision Medicine Initiative.

I believe this legislation will have a profound impact on the pharma / med-tech industry. Over the near term - say the next five years - money will flow into the sector from both public and private investment. The hurdle for FDA approval has been lowered and I believe investors will see this as a "risk on" opportunity in the industry. The smallest players will benefit the most because financing should become available for more projects and the path to market has been eased. Funding of $6 billion seems small to industry giants like Pfizer and Novartis, but it's a game-changer to small- and micro-cap players. NPV's are going to go up and stock prices should follow.

Bubbles, Bubbles, Everywhere...

Bubbles are a fact of life. Dating back to "tulipmania" in 1635 Holland, investors quest for excessive returns fuels over-speculation that leads to the formation and eventual popping of bubbles. The U.S. Government, through its domestic and foreign policy, as well as both fiscal and monetary policy, is the single biggest creator of financial bubbles. There are bubbles in the stock market, in the bond market, the housing market, the oil market, and the commodities market. These bubbles can be broad, affecting the entire market, or industry specific.

For example, it is widely accepted that the U.S. government repealed or implemented several laws that limited the regulation of the banking industry, such as the repeal of the Glass-Steagall Act and implementation of the Commodity Futures Modernization Act of 2000 that directly cause the housing market bubble of the late 2000s. The repeal of Glass-Steagall allowed depository and investment banks to merge while the CFMA limited the regulation of financial derivatives. Throw in laws like the American Dream Downpayment Assistance Act of 2003 and cheap money from incredibly low interest rates and, voila, you get a housing bubble a few years later.

It is also widely believed that the establishment of the Federal Reserve in 1913 and the end of The Great War in 1918 lead to the stock market bubble of the roaring 1920's. The Telecommunications Act of 1996 flooded capital into the telecom industry, incentivizing firms, new and old, to begin building networks over land, undersea and in the air. I recall one of my first assignments as a buy-side analyst was to perform a SWOT analysis on several competitive local exchange carriers, dubbed "C-LECs" back in 1999. This was an incredible booming market in 1999; the bubble burst in 2001.

Both a booming telecom industry and the Taxpayer Relief Act of 1997 are partly responsible for the Dot-Com bubble of the late 1990's. The Energy Policy Act of 1992 eliminated obstacles for wholesale electricity competition, and without it, we would have never have had Enron. At the start of the Iraq War in March 2003, oil was $40 a barrel. Five years later, the Middle East was a quagmire and oil eclipsed $150 a barrel.

The housing market implosion and the soaring price of oil lead to the financial crisis that caused the Great Recession between 2007 and 2008. Between 2007 and 2012 the price of gold tripled in value. To pull us out of the recession, the Federal Reserve started the policy of Quantitative Easing. The U.S. had a near-zero interest rate policy and money remains incredibly cheap today. Many believe we are currently in a Bond Bubble as a result of these policies.

You Want To Get Rich? 

If you want to truly get rich playing the stock market, find a bubble! Find a bubble before it forms and ride it to the top. You do not need to be a perfect market timer either; history shows us that bubbles form over many years and take asset prices to levels unfathomable at the start of the cycle. History also shows us that when bubbles burst it is quick and exceedingly painful. Similarly, asset prices plunge to unfathomable levels on the low end.

Blue Horseshoe Likes Bubbles

It's Dega Vu All Over Again

You cannot really fault the government, for they know not what they do. Most of the members of congress have little to no real world business experience. Even less have experience in the healthcare industry. Perhaps the U.S. FDA is the biggest loser of the Act. They get only minimal extra funding - a palty $500 million - and are now expected to expedite approval for potentially hundreds of new drugs and devices over the next several years. The researchers and the lobbyist won, but the buck still stops with the FDA. 

Who know's what will become of the Act in 10 years. Perhaps it will be the saving grace of the U.S. healthcare industry or perhaps dozens of new, ineffective and potentially unsafe medications will flood the market by 2022. Consumer advocacy groups that lobby for drug safety and empirical evidence also lost big. The FDA clamped down on the approval process after Merck pulled Vioxx from the market in 2004. It was a black eye for the agency and the bar only recently has come down (see FDA drug approvals by year). 

While the Act makes me fear for where the industry may be in 2023, I think the U.S. government has once again created legislation that may lead to a bubble. That may be hard for some investors to come to terms with considering the pharma/bio industry has done exceedingly well since 2009; but, keep in mind that bubbles take asset levels to ridiculously high prices - oil at $150 per barrel, gold at $2,000 per ounce, and 600 sqft condos in Miami for $1.5 million. No, the XBI has a long way to go before I think we hit "ridiculous levels".

Bubbles are also incredibly hard to spot before they form. No one stood up after the Telecom Act in 1996 and said, "This will create hundreds of small telecom companies and an industry boom like we haven't seen since the railroad industry of the late 1800's!" It did, and it ended with the implosion of Lucent, Alcatel, Global Crossing, Ericcson, and Worldcom. Nor did anyone say in 2003 that the U.S. would enter a massive housing bubble spurred by cheap money and new "everyone gets a home" federal policies.


Many things create bubbles, but greed and government legislation play a major role. The passing of the 21st Century Cures Act kicks open the door for a potential biopharma / med-tech bubble to form over the next several years. It will be driven by increased capital investment and expedited drug / device approvals. Those odds are as good as any previous bubble noted above. Sure, the drug pricing issue remains and an occasional Tweet may send the indexes down over the short-term, but forces are lining up that make me want to be very greedy over the next few years.


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BioNap currently has 40% of its equity portfolio allocated in healthcare stocks.

1 comment:

  1. Great post Jason! I hope you're right!!