Biotech stocks had a bad week. And after a long winning streak, the selloff stoked fears that biotech had been in a bubble—and that the bubble might be starting to burst.
The sector lagged both the S&P 500 and the Nasdaq this week, losing more than 5% as shares of some biotech firms recorded double-digit declines. Biogen (BIIB), one of the biggest companies in the index, for example, fell nearly 10%, while Isis Pharmaceuticals (ISIS) ended the week down almost 14%. Other biotech firms, including Celgene (CELG), Regeneron (REGN), Vertex Pharmaceuticals (VRTX) and Alnylam (ALNY) also lagged. (For a guide to biotech investing, see “Biotech pros’ top 8 stock picks” from Fortune’s March 15 issue.)
The bearishness apparently started last Friday, just as the Nasdaq Biotechnology index hit a new high. Biotech giant Gilead (GILD) warned that it had observed a potentially fatal reaction when patients took its blockbuster Hepatitis C drugs along with a heart disorder drug called amiodarone.
Gilead’s drugs have been so successful, more than doubling the company’s revenues in 2014, that the news threatened investors’ confidence in biotech as a whole. A Baird biotech analyst even had to spend his weekend talking his clients down from bailing on the sector completely, The Street reported.
Shortly after, The Wall Street Journal reported that investors were worried that biotech stocks could bring down the Nasdaq the way dot-com companies did 15 years ago.
And StockTwits CEO Howard Lindzon told Yahoo Finance that biotech stock performance looked “very scary.”
For all the panic, though, there are signs that the biotech dip may just have been a temporary hiccup on the way to new highs. The correction brought biotech stock valuations down substantially: The average price-to-earnings ratio of the Nasdaq Biotechnology Index, while still more than double the average of the overall Nasdaq, is about 10% lower than it was a week ago, when it reached its highest level this year. That means that biotech valuations deflated more than the stocks did themselves.
Gilead, for one, now trades at just 10.6 times its estimated 2015 earnings—a valuation that’s not only half as expensive as its average Nasdaq peer, but so low that it’s hard to find anywhere in the stock market these days. Indeed, by that measure, Gilead is even cheaper than Gazprom, Russia’s state-owned gas company.
Nasdaq senior analyst Joe Rosenberg chalked the biotech selloff up to normal mean reversion—after the Nasdaq Biotechnology Index returned more than ten times the S&P 500’s 2% return year to date, it makes sense for the sector to take a breather.
In fact, a similar pattern occurred about a year ago, when the biotech market fell off a cliff, correcting 21% in a six-week swoon. Still, by the end of 2014, biotech had returned more than 34% for the year.
And the rally may have started already: biotech stocks perked up on Friday, pulling ahead of the rest of the market again with a 2% gain.