It was a great summer for big pharma stocks. Investors shouldn’t expect that trend to reverse this fall.
As has become routine, biotechnology stocks had a strong summer. A broad index of those stocks is up about 15% this year and is near a record. This time, however, major pharmaceutical companies are joining in the rally.
Pfizer , PFE 0.73% long one of the sleepier stocks in the Dow Jones Industrial Average, is up nearly 20% since the start of the summer. It, along with similar-sized rivals like Eli Lilly LLY 0.80% and Merck MRK 0.72% & Co, are trading near two-decade highs.
There are no obvious explanations for the sudden investor interest. While second-quarter earnings were strong across the sector, they were hardly memorable. No other events, such as new clinical-trial results or large-scale deal-making, explain the rally.
But the absence of a clear catalyst doesn’t mean that the sector is due for a reversal. Even after the rally, Pfizer and Merck trade at about 13 and 15 times forward earnings estimates, respectively, according to FactSet. That is still cheaper than the S&P 500, which fetches more than 17 times.
More important, it is hard to see any looming negatives that would lower earnings expectations.
While the Trump administration continues to roll out its plan to reduce drug prices, the administration has focused primarily on middlemen such as pharmacy-benefit managers instead of manufacturers. Those policies aimed at pharma are more subtle than investors had feared. For instance, the Centers for Medicare and Medicaid Services announced last week that it will give Medicare insurance plans more flexibility in deciding whether to reimburse for drugs approved to treat multiple diseases starting in 2020. That has the potential to affect sales of certain blockbuster drugs and could damage share prices of smaller companies.
But fears of wholesale price controls, which torpedoed the sector ahead of the 2016 election, have faded away. Midterm elections in November seem unlikely to alter that picture.
Given that backdrop, pharma stocks would have to go much higher before investors should worry about any potential negative side effects.