What the Fed Rate Hike Means for Healthcare Stocks

With additional rate hikes projected, how will life science stocks respond?

fed rate hike, federal interest rate

In a unanimous vote, the Fed yesterday increased its benchmark interest rate to a range of 0.5 and 0.75 percent. No surprise there—the markets widely anticipated this raise. What was less expected were the Fed’s projections for the year ahead: it predicted three rates hikes in 2017. American stocks closed widely lower following this announcement, with the greatest losses seen in the energy and utilities sectors.

But how did life science stocks respond? And more importantly, what will this mean for the healthcare sector going forward?

Defying other market trends, the NASDAQ Biotechnology Index (INDEXNASDAQ:NBI) rose 3.56 percent yesterday. The iShares NASDAQ Biotechnology fund (NASDAQ:IBB) also made gains: it rose .37 points on Wednesday and continued to climb in morning trade today.

Of course, there’s no guarantee that a rate hike will continue to boost this sector—at least not if history is any indication.

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Higher rates make merger deals more expensive. Meanwhile, dividend-paying stocks—read: big pharma companies—lose some of their competitive edge: after all, rising interest rates boost returns on T-bills and and short-term bonds. And of course, funding can be harder to come by, particularly for smaller biotech companies.

What happened last time?

It’s been almost a year to the day since the Fed last raised interest rates. On December 16, 2015, it hiked rates by 0.25 percent. Back then, as CNBC reports, the market responded well—at least in the short term. The S&P 500, for example, gained 1.45 percent. But by mid February 2016, it had plunged over 11 percent.

The NASDAQ Biotechnology index had a similar showing: On the heels of the hike, it gained 2.31 percent, or 79.7 points. But by the end of January 2016, it was down 18.96 percent.

Of course, biotech and pharmaceutical companies were facing other hurdles (for a quick summary, check out our recap of the year). Nevertheless, the Fed’s decision did have a solid impact on the life science sector.

Following the rate hike in 2015, one would’ve expected to see less merger activity, reduced investment in big pharma stocks and a shortage of venture capital in the biotech space. Let’s go through each of these in turn to see what really happened.

1. Less merger activity

There was significantly less merger activity in 2016. According to this PwC report, the third quarter of the year saw a 65 percent decrease in deal value, as compared to Q3 2015. The number of deals was also down—by 24 percent.

2. Reduced interest in pharma’s dividend stocks

This one is harder to assess, especially given pharma’s rough year. The election, paired with growing public and regulatory concern over drug prices, frightened many investors away from the pharmaceutical sector.

Many of the big pharma stocks increased their dividend payments in 2016, including Novartis (NYSE:NVS) and Johnson & Johnson (NYSE:JNJ). But this isn’t necessarily unusual, or a sign of companies trying to win investors back: dividend-paying stocks often try to raise their payment annually.

3. Decreased funding for small biotechs

According to this PwC report, venture capital did decrease for biotechs in 2016. In the states, funding for the life science sector declined 17 percent by value and 26 percent by volume in the third quarter of the year.

However, that doesn’t mean venture capitalists are avoiding the space—in fact, biotech, and the life science sector as a whole, attracts more money than most other industries. It’s second only to software.

Biotechs also didn’t shy away from IPOs in 2016. Gene-editing company Editas Medicine (NASDAQ:EDIT) was the very first company of the year to go public in the US—and its stock promptly soared. More than 25 biotechs have joined it in the months since.

Looking forward

Clearly, all those doom and gloom predictions didn’t come true following the last federal rate hike in December 2015. Pharma and biotech stocks may have had a tumultuous year, but that can’t all be put down to the Fed’s decision.

Heading into 2017, it will be interesting to see how yesterday’s rate increase—paired with expectations for further hikes—will impact the life science sector in the long term.

Don’t forget to follow us @INN_LifeScience for real-time news updates.

Securities Disclosure: I, Chelsea Pratt, hold no direct investment interest in any company mentioned in this article.

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