In Part 1, I focused on the effect the shareholder base and portfolio managers have on these shares, but there are other things to consider as well.
I like to think of biotech stocks as black double diamond runs on the slopes: they are fabulous to ski on when the powder's perfect and the sky is blue, but foolhardy to go down on when it is frozen, stormy and icy.
Now, how about those big pharma stocks that are protected by their dividends? Can we take solace that they are true safe havens?
Because there's another part of the landscape that changes in times of stress: currencies. The world's money flows seek to be in the strongest currencies for protection against the chaos that might be occurring elsewhere. The U.S. right now is perceived as the strongest nation on Earth, and its currency therefore attracts capital from all over the world.
That's terrific if you are a buyer of goods from overseas. It is not so terrific if you sell them overseas in weaker currencies and then try to translate those gains back to the U.S. One of the reasons why the U.S.-based pharmaceutical companies do so well is because they have huge worldwide sales. But when the dollar gets stronger against the currencies in which they sell overseas, the companies make less than the analysts thought they would have, because the U.S. profits are reduced by those declines. In simple terms, estimate numbers get cut for big pharma every time the dollar rises against a basket of currencies.
So when you hear, "cutting numbers Merck (MRK)," that stock (which is a holding of the Trifecta Stocks portfolio) is going lower. That's what happens. And Merck's 3% yield doesn't help much against, say, a three or four point decline in the stock because of the estimate cuts -- a very realistic possibility.
Let's make it even tougher for Merck. If the Federal Reserve thinks that our economy is on solid footing and wants to start the process of taking up short-term interest rates, then the dividend yield isn't as attractive as it would have been vs. cash itself, and higher short-term rates will make dollars even more sought-after by foreigners than before. So numbers come down AGAIN, and the dividend yield is even less of a protection.
So now, let's come full circle: Chinese turmoil breeds an aversion to risk which then causes stocks, especially riskier stocks like biotechs -- without dividend or even earnings protection -- to fall harder and faster than others, exacerbated by a weaker shareholder base many of whom are playing with borrowed money, who must sell as the stocks go down. Big pharma stocks are safer, but their earnings are hurt by a stronger dollar and the dividend doesn't protect the principal from declining much, especially when the dividend yield is challenged by competition from risk-free assets like Treasuries.
So, long story short, neither biotech nor big pharma stocks are truly safe from the China syndrome, so to speak.
Now, let's layer on one more positive complication. Take yourself outside the stock market. Picture yourself as the head of a major pharmaceutical company that does not have a strong pipeline of drugs or needs to augment its current, undiversified pipeline. Its actual core business, as the tweeter first suggested, is doing just fine. The company has a lot of money. What does it do when these biotechs come down?
It buys them. Think of Celgene (CELG) buying Receptos (RCPT) for $7 billion to diversify away from its blood cancer franchise. Think of AbbVie (ABBV) purchasing Pharmacyclics for $21 billion to get a better call on cancer drugs.
That's right, the real world collides with the stock world to create bargains for companies like Celgene and Abbvie to take advantage of.
So look at it as a process. While biotechs and pharma stocks invent and sell products that are immune from business cycles that could be hurt by a flailing China, their STOCKS could be hurt regardless of the steadiness of their research labs or product sales.
But once the stocks come down hard, the dividends of the big pharma companies might offer some protection to the shareholders, although perhaps not enough to offset losses of principal, especially when you consider the suspect earnings streams that come from weak currency translations.
Biotech stocks get sold down because they are too risky, but then biotech companies get scooped up because they get cheap enough that their pipelines become accessible to old-line pharma looking to upgrade.
In the end, that's why I say let the worldwide turmoil bring down the stocks of the companies you like to levels where good things can happen.
But understand that regardless of what they sell or do, these companies' stocks should and will go down on world recession before they bounce because of other, more positive characteristics that can save the day and produce steady gains when the smoke of the distant fire at last clears from the planet.