Good Prognosis for Health Care Stocks

Yesterday I talked about some of the reasons why I am becoming slightly more optimistic. One thing that I neglected to talk about is leadership. In past bull markets, the average bubble corrects 75%, this according to my colleague Keenan Hauke at Samex Capital. He joined me last week on The Opening Bell. He did some research and looked at past bubbles and busts. Here’s what he found:

The average bubble corrects 75%. Examples include:

- Dow Jones Industrials in 1932 fell 76% from the 1929 peak

- Nifty fifty stocks in the early 1970’s fell 71%

- Gold fell 73% from 1980-1999

- Japan’s Nikkei fell 78% from 1990-2003

- Tech fell 76% from its peak until October of 2002

So where will the next bubble develop? As Keenan points out, bubbles rarely, if ever, come from the sector that burst -- in this case, homebuilders and financials. So where should we look, or is too soon? Some might argue that we have been in a commodity bull rally. While gold has pulled back from $1037 at its peak on March 17 to as low as 802.34 yesterday, or a 22% correction, it is still up 48% in two years, assuming the July average of $939 versus the July average in 2006 of $633.71. Not bad!

My pick for the next bull market is health care and biotech. In the past couple of weeks we have seen at least three deals or partnerships announced. Bristol-Myers announced its intent to purchase the remaining percentage of ImClone that it doesn’t own. Eli Lilly announced a research and development deal with Covance, a drug-development service company, worth $1.6 billion dollars, that offsets some of Eli Lilly’s burden to develop and test new drugs. Note that the cost to get a drug FDA approved and on the market on average costs a drug maker $1 billion dollars and years to develop and distribute. In some cases a decade!

A company like Covance in the research business can cut the costs dramatically for a drug maker like Eli Lilly and improve their efficiencies. On early-stage development and testing, it can cut the process down by 20-30% or approximately 2 to 4 months and can speed up clinical trials by as much as six months. Usually it takes three clinical trials to get a drug approved. The outsourcing arrangement that Eli Lilly made is one that many other drug makers are considering as costs are ballooning.

Not too long ago Swiss drugmaker Roche made an $89 bid for the remaining portion of Genentech that it does not own. Analysts are in agreement that Roche will have to raise their bid, this as shares of Genentech keep hitting new highs.

Now, this morning, word of a deal between CVS and Longs Drug Stores for $2.6 billion dollars, or a 32% premium to where the company was trading yesterday. The deal was announced after the bell. This is a story about drug-store chains, not drug makers, but it just goes to show you that this segment is hot and my guess is it will get a lot hotter. Think about some of these statistics: 47 million Americans do not have insurance, the cost of prescription drugs has increased 16% over the past five years, 15.8% of Americans had no health insurance plans and employers will spend about 10% more in 2009 on health-benefit packages (down from the mid teen’s in the early 2001-2002 period). This morning I will be talking to members of both McCain and Obama’s economic team about each candidate’s health-care plan. Stay tuned.

Look at the DRG and BTK. The Drug Index and the Biotech Index. The DRG is down 5.7% over the past 12 months, but the BTK is up 14%.

Food for thought!