Monday Morning: Drugs and biotech: Flashes in the pan?

OK, George W. Bush is the president-elect, and the Fed has cut rates. Now what do financial planners and investment advisers tell their clients?

Already, some analysts and portfolio managers are declaring drug stocks and biotech stocks as the place to be for the foreseeable future, replacing the dot-coms.

As they see it, the election of Mr. Bush has ended the threat that government price controls and tighter regulations would hurt drug stock profitability. The fear of such price controls and Vice President Al Gore’s anti-drug-company campaign rhetoric was blamed by many for lagging drug stock performance much of last year.

positive karma

Now the path seems clear for the drug companies to continue to profit handsomely from their products. The story is that the demographic trends make increased spending on drugs inevitable. In addition, new breakthroughs by biotech companies will produce stunning products and medical advances.

Unencumbered by the threat of price controls, companies producing those new drugs and advances stand to harvest huge profits.

But not so fast. Mr. Bush has been elected for only the next four years, and Republicans have a guaranteed majority in Congress for only two years (less if a Republican senator from a state with a Democratic governor should die).

If the Democrats gain control of Congress in two years’ time, the threat of price controls for drugs could return. Or, if Mr. Bush were defeated by a Democratic candidate in four years, the price-control issue would likely rise again.

Either development would no doubt put drug stock prices under renewed pressure. In addition, even a Republican Congress and president could not sit by idly if medical spending surged out of control because of extremely high drug prices.

For short-term investors, drug stocks and biotech companies might well be a place to overweight in a portfolio. But such investors should do so with the expectation that they will have to time their departure from the stocks very carefully.

patience and prudence

For long-term investors, the dot-com meltdown was simply confirmation that a well-diversified portfolio constructed with care, taking into account the investor’s goals and risk tolerance, offers the best chance of satisfactory results.

Those financial planners and investment advisers who kept their clients well diversified, and persuaded them to merely sip the enticing waters of the dot-com flood, no doubt still have mostly happy clients.

Those who were unable to prevent their clients from getting swept away by the dot-com and tech stock euphoria will, no doubt, receive calls from many unhappy, and possibly soon-to-be former, clients as the scorecard for last year is totaled.

One of the most important responsibilities of a financial planner is to keep clients focused on the long-term goals. If they can do that, they will be able them to prevent clients from being swept up in the market euphoria that often leads to painful losses.

Now such advisers will have to be on guard against the next hot sector, such as drug and biotech stocks. Wall Street is never short of new, hot, can’t-miss investment ideas for the unwary or greedy investor. And they all come with great stories backing them up.

Investment advisers earn their keep, in part, by helping clients discern which of the stories are true, and then to act prudently to take advantage of them.

Mike Clowes is the editorial director of InvestmentNews.

Related Topics: Just Thinking