I was going through my email today when I came across some really insightful comments made by Jayson Parker, who is an associate professor of my Biotechnology program. With his expressed consent, please review some key points that highlight the effects of the US “subprime melt down” that is taking place and their relevance to the biotechnology industry.
He explains that there are two basic outcomes:
1. Core inflation is priority. If interest rates go up, it hurts biotech (as it is capital intensive and increases the cost of money for loans).
2. The housing market continues to meltdown in the US. If interest rates go down in response to a recession precipitated by the housing meltdown it will also hurt biotech (money is cheaper, but investors will assign a much higher risk to stocks and the flow of money will decrease).
Recapping some events that have take place so far:
- The US economy has defied gravity for the past several years given the unexpected strength of consumer spending.
- Consumer spending has been made possible by unprecedented appreciation in housing values and historically low interest rates – consumers have borrowed against this to maintain their purchases.
- Unlike previous market bubbles, a substantial portion of consumers have leveraged themselves to be part of this current bubble – the housing market.
- Some consumers have borrowed heavily enough against the price appreciation of their homes – that a strong market correction could leave them owing more money on their homes (negative equity).
- In a historically low interest rate environment, some mortgage companies have offered loans to high risk clientale (e.g. NINJA – loans to folks with no income, no job and no assets) assuming far greater risk in their client base than is normally prudent.
These risky loans have been “securitized” – meaning the debt has been repackaged – and through a series of events I don’t follow – have been included in other investment vehicles that affect more broadly the retail market.
- The housing market in the US – which has seen more growth than in Canada – is the “canary” of US economic outlook – recent interest rate increases have seen an increase in bankruptacy rates among homeowners who cannot make their monthly payments.
Currently, the US federal reserve is meeting over the next two days to decide on whether interest rates will climb – the expectation is that it will remain status quo. Core measures of inflation (excluding indices of energy), indicate that inflation may be a concern which will eventually demand an interest rate increase. Finally, giving the “recap” above, the Federal reserve will likely will be more focused on the Housing market and in keeping bankruptacies to a miniumum by keeping interest rates as low as possible to avoid a recession. Keep your eyes on the subprime meltdown in the US over the next quarter. If we enter into a recession, there will be harder times for biotech.
Once again, I would like to thank Jayson for his insightful comments!