The question's a simple one on its face: "what do the biotechs and new old/pharma have to do with the China rotation?"
@jimcramer what do the biotechs and new/old pharma have to do with the China rotation?¿ Tuliani (@Tuliani) August 27, 2015
The problem is, the answer's incredibly complicated, because on the one hand, they should have nothing to do with each other and on the other, they are deeply intertwined. It's the intersection where there's an amazing amount of both treachery and opportunity.
First, let's accept that the Twitter reader's baffled because the fortunes of biotechs and old pharmaceutical companies have very little to do with the fortunes of China.
Regardless of whether there is a slowdown in economic growth or a stock market that seems to go down almost daily except last night, something's rotten in China. But it isn't so rotten or pervasive that it is going to hurt drug sales of a company either like Celgene (CELG) or like Dividend Stock Advisor portfolio holding Pfizer (PFE). People get sick, they take medicine.
So on the surface the answer is that they have nothing to do with each other, so any weakness that's ostensibly caused by China woes shouldn't impact these stocks. That would mean that you should be a buyer of both if they decline on China.
That's not a totally wrong assumption. Many are making it; some are putting their money to work in these stocks because of it. They could be very right, but not necessarily for those reasons.
That's why I don't want to be dismissive of it.
But let's layer on some complications that come into play.
There are all kinds of money managers, ones who want to have lots of exposure to stocks, ones who want lots of fixed income, ones who don't like risk and ones who do.
If China's really in trouble, meaning if its economy is downshifting more quickly than people realize, then it could cause a worldwide recession and many of the companies that provide raw materials to China will find their balance sheets stressed. Some will default.
If a manager who has a choice between stocks and bonds knows that a worldwide recession could occur, he also knows that creates pressure on the riskiest assets and makes the safest prized. Think back to 2007 to 2009, you wouldn't describe stocks as a safe haven vs. that economic backdrop, would you?
China's the second largest economy on Earth. If it implodes, then you can bet that some managers are going to think it is 2007 to 2009 all over again, and they are going to run from equities into bonds worldwide.
Biotech and old pharma stocks are part of the indices and they get sold down.
Now, in that same scenario, bonds become safe havens, driving down interest rates even further than they have come down.
That puts a floor under companies that pay above average dividends, as many of the big pharmaceutical companies do. So they could go higher in this scenario. But the biotechs don't pay dividends.
In a time of turmoil the speculator class, which tends to use borrowed money and buys biotech with it because that's where the biggest gains come from, comes under stress. As these stocks come down along with all others and don't have the support of dividends, the speculator class, your fellow shareholders in many of these stocks, gets margined out, or sold out by margin clerks right out from underneath them, because they don't have enough capital to make margin calls.
In other words, the profits of, say, Regeneron (REGN), won't be hurt by the turmoil, but the stock could go down as part of a worldwide retreat of all stocks and then the decline would be accelerated because speculators who were renting the stocks for quick gains get evicted because they borrowed money to finance their purchases.
So, you have a real bad shareholder base coupled with the fact that portfolio managers always want to take on less risk in dicier times, and it isn't like the biotechs are brimming with earnings to fall back on. Most of them lose money and trade up not on earnings, but on drug approvals.
I discuss currencies and mergers and acquisitions in Part 2.