The biotech bear market from February 2021 through October 2023 created some dramatically underpriced stocks. There is free money lying on the sidewalk, just waiting for you to pick it up.
Dear Biotechies:
Is the economy hot or not...and does the Fed care? The answer is that it is stronger than the Fed expected, but they don't directly care. What they care about is inflation and unemployment – those are their two mandates.
Inflation
We got the March Consumer Price Index (CPI) inflation report, which is not the Fed’s preferred measure of inflation. They have repeatedly said that they look at the core Personal Consumption Expenditures Index (PCI) to get to their 2% target. The next PCE announcement comes April 26, before the May 1 Fed meeting. March's CPI increase was driven by elements not included in the PCE.
First, the numbers. Headline year-over-year (YoY) inflation was 3.5%. That was up from 3.2% in February and a tick above the 3.4% expectation. The core YoY number, excluding food and energy, was 3.8%, the same as February but also a tick above the 3.7% consensus. Essentially, the markets panicked Wednesday over inflation topping the consensus estimates by a tenth of a percent. The deflation of core goods intensified, showing a YoY decrease of 0.7%, while the growth rate for core services accelerated, reaching +5.4%.
As usual, the lagging Cost of Shelter component contributed most to the slow CPI decline. Cost of Shelter includes the rent paid by tenants for housing and something called Owner Equivalent Rent, calculating the hypothetical amount homeowners would pay to rent their own homes, which obviously is affected by what renters actually pay. The “Rent of Primary Residence” component came in at 5.67% YoY, which was the lowest reading since May 2022, but still reflecting early 2023 rents rather than today's generally lower reality.
@ernietedeschi, former Chief Economist at the White House Council of Economic Advisers, showed how the Zillow single family rent data leads the CPI shelter component by 12 months:
h/t @ernietedeschi
@jayparsons, a rental housing economist, showed this chart:
h/t @jayparsons
Cost of shelter – the two rent measures – accounts for 32% of the CPI and 43% of the core CPI. The blue line above shows real asking rents are up 0.20% YoY, not the 5.68% the Bureau of Labor Statistics used. If we multiply that 5.48 percentage point difference by the 32% that rents account for in the CPI, we get an overstatement of 1.75 percentage points. Subtract that from the 3.5% reported and annual inflation was just 1.75%. Using the same methodology, core CPI falls from 3.8% to 1.5% (h/t @OphirGottlieb).
The month-over-month (MoM) increase was 0.4%, unchanged from February but a tick above economists' forecast. The core MoM increase, which is a marginally useful number for figuring out what is really going on, was up 0.36%, also the same as February and also well above the consensus. A 0.36% monthly increase compounds to well over 4% annual inflation. Not good. The futures market has now pushed out the first rate cut into September. I think that the Fed will either cut by June or not at all to avoid looking partisan in the lead-up to the election. As I've been saying for months, “high – but not higher – for longer.” You heard it here first.
Unemployment
The Bureau of Labor Statistics said the US added 303,000 jobs in March, more than 50% above the consensus forecast for 200,000 and the largest gain in 10 months. The odds of all economists surveyed missing their nonfarm payrolls forecasts by such a wide margin for three straight months seem awfully low to me, but we'll have to wait until after the election to see the final revisions.
In the real world, corporate cash and free cash flow are at record high levels, supporting stock prices as we head into March quarter earnings results.
h/t @JessicaMenton
Market Outlook
The S&P 500 added 1.0% since last Thursday as inflation reality came in not much worse than – maybe even a little bit better than – inflation fears. The Index is up 9.0% year-to-date, and has been much stronger seasonally that in a typical Presidential election year. You could argue that means (1) it's ahead of itself; or, (2) that it's a powerful sign of underlying strength. I think it's both, so we'll probably see high-level churning through the election.
Although April should get better after next Monday.
The Nasdaq Composite gained 2.4% as investors looked ahead to March quarter earnings, especially in technology. It is up 9.5% for the year. The SPDR S&P Biotech Exchange-Traded Fund (XBI) climbed 2.0% as riskier assets caught a bid. It is only up 2.2% year-to-date, though
The small-cap Russell 2000 fell 0.5% and is (barely) up 0.8% in 2024. BofA said: “The Russell 2000 remains historically cheap vs. the Nasdaq, and as the overall corporate profits backdrop continues to broaden/accelerate, we see better trends for US small caps.”
h/t @dailychartbook
The newest Conference Board survey showed 49.3% of consumers expect higher stock prices. That number has only ever been higher once, in January 2018 at 51.0%. Following that instance, the S&P had mildly negative returns over the next 12 months, followed by a huge rally.
h/t @dailychartbook
The fractal dimension continues to grind out the necessary consolidation. As I said last week, this could continue for quite a while.
Economy
The Atlanta Fed's GDPNow model now is predicting March quarter real GDP growth of +2.4%, still a bit above the consensus for +2.1%. We get the first estimate in two weeks on April 25.
Variant Perception has a proprietary VP Leading Indicator of US economic conditions, and it is clearly inflecting higher:
h/t @VrntPerception
I may have to change my mild recession forecast if this keeps up.
Biotech Focus
Valuing biotech companies is hard. The must-follow @learnbiotech posted an interesting graphic today:
They wrote: “When thinking about valuing biotechs, especially those which are not yet profitable, a probability adjusted discounted cash flow model is perhaps the most important methodology Though it too has drawbacks.”
It sure does. I've been valuing companies for decades, and I used to do detailed DCF models. But they have at least two big drawbacks. First, if you think the problem with the sales multiple is that its a future estimate, try adding estimates of future marketing, G&A, R&D, and tax estimates, because that's the minimum you need to do a DCF calculation. Second, when your elaborate spreadsheet is done there is a tendency to believe it. After all, you did all that work!
But the purpose of modeling is not to make accurate forecasts. It is to understand the dynamics of the business you are looking at, suss out the often-hidden profit levers, and try to get a feel for the real risks.
I quite agree that P/E and EV/EBITDA ratios are of “minimal use,” although I prefer the term “useless.” I think the best approach begins by calculating possible peak sales of a drug times – here it comes – the probability of getting FDA approval. Many years ago, Bob Swanson, co-founder and CEO of Genentech, said this business is not about developing great drugs, it is about getting drugs approved by the FDA.
I didn't say the alternative to DCF would be easy. You can't just plug in the average failure rate in Phases 1,2, and 3 (although that's a good place to start). Guessing the probability of getting FDA approval when that Agency goes through periods of high and low approval rates isn't easy.
Of course, you also have to estimate the amount of capital and therefore future dilution it will take to get a drug to home plate. A drug like Inovio's INO-3107 that can get approval based on a Phase 2 trial really interests me for that reason. By putting together these three numbers – peak sales, FDA probability, and dilution, you can get a rough estimate of the current value of the stock to compare to the current price.
And because all estimates are rough, including DCF values, it won't make you overconfident that you actually know the future.
Biotech Moonshots Portfolio Update
Biotech, small cap, and growth had a tough week, so the Moonshots portfolio fell 4.0%. There's enough clinical and other data coming to drive our performance much higher in 2024. Let's dig in...
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Perception: Almost 50% of Millennials and a majority of Gen Z think “Racial minorities in the U.S. have no hope for success because of racism.”
h/t @TheRabbitHole84
Reality: Some of the most successful groups in the United States are racial minorities.
h/t @TheRabbitHole84
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Your reviewing The Battle of the BADS Editor,
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