Subprime Melt Down Effects on Biotech

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!

Global Market Volatility: Sub-Prime Mortgages

This has been another wild week in the markets. The U.S. sub-prime mortgage problem is effecting markets worldwide. Yesterday, there was a massive sell-off in North America [GlobeInvestor], which caused a 2% decline in Asian and European markets. Specifically, the Nikkei 225 index dropped 2.92%, the Hang Seng lost 2.8%, Indian stocks dropped 3%, and Phillipine stocks lost 3.4% overnight. Subprime lending to people with poor credit ratings is the culprit behind this downward market pressure. We are seeing a number of large financial institutions finding themselves in a bit of trouble. An announcement from H&R Block Inc. dictates that they had to writedown $29 million off its mortgage arm due to bad debt. The HSCB is also having some problems of its own as they have mismanaged their US mortgage portfolio, having bad debts soar to $10.6 billion.

Lee Cheng Hooi at EON Capital in Kuala Lampur stated “the worry is that it could spill over and cause the U.S. economy to slow down, and this will cause a domino effect on the world economy.” Kim Yung-min, a fund manager at SH Asset Management in Seoul added, “if the U.S. sub-prime mortgage problems get worse, it could begin to hurt U.S. consumers, and that would be very hurtful for exporters. This month could be very bad.”

In Canada, the market may be supported by metals and energy stocks as oil hovers around $58 a barrel. The Canadian index is up 13.93 points so far today, let’s see how it finishes up the day!

This is the second time within the past half month that we have seen distinct cases demonstrating global volatility to actions that occur in geographically dispersed markets. Remembering back to the end of February 2007, the Chinese stock markets plunged to set off a worldwide sell-off with the Shanghai composite losing 8.8%, and the Shenzhen composite losing 8.5%; this caused markets to fluctuate around the globe including a 3.3% loss on the Dow. Some think that this was simply a correction due to large gains seen on the Asian markets for the many months preceding.

This is a different story. Could we be on the brink of a recession in the US? Will Canada also fall into this spiral? If mortgages, and subsequently, real estate markets tumble, consumers will not be able to spend as much on goods and services, etc, etc …

Let’s just hope this was another ‘correction’ in the marketplace.