The Biotech industry as a whole continues to underperform the market so far this year. As of May 26, 2009, Both the AMEX Biotech Index and the broader NASDAQ Biotech Index declined 6.8% (AMEX Biotech has 20 biotech companies while NASDAQ Biotech Index includes over 130 component companies), while the Dow Jones Biotech Index declined 3% (which includes 33 companies).

At the same time, both the NASDAQ Composite and S&P 500 have achieved positive returns. NASDAQ has made a gain of 11% as of 5/26/09 and the S&P 500 has gained 0.8%, while the Dow Jones Industrials reached a negative 3.5% return.

This constitutes a sharp contrast with last year when the Biotech industry as a whole achieved much better performance than the market. In 2008, all three biotech indices outperformed all three major market indices by a large margin. The three major indices declined as much as over 40% (34%, 41% and 38% for Dow, NASDAQ and S&P 500 respectively). While the NASDAQ Biotech Index declined only 12.6% and the AMEX Biotech Index was down 17.7%, the Dow Biotech Index actually had a positive 3.7% return in 2008.

This can partly be explained that when the recession gets deeper, even large-cap biotech companies will feel the pinch, while the smaller ones are still struggling with survival. Usually large-cap biotech companies, like large-cap pharma ones, have more resources to withstand economic downturns and financial crises than smaller biotech companies which have limited revenue and cash reserves. The current economic and financial environment has exerted negative impact on even large-cap biotech companies when patients curtail their out-of-pocket expenses.

Valuation is attractive though. The industry's average P/E (TTM) ratio has declined to 16x from a historical 35x to 40x. The five-year PEG ratio is less than 1 at 0.97, according to Yahoo Finance. But big pharma and biotech companies still face three major challenges: patent expiration, low research and development productivity, and generic competition.

We expect continued M&A activity in the remainder of the year after a series of mega deals in the first five months of the year. We believe the current market environment in the Pharma/biotech industry is favorable for M&A activity. With very active M&A's in the pharma/biotech sector, investors have every reason to speculate on buyout targets. Opportunity also exists in companies with decent pipeline which may attract big pharma or biotech companies for partnerships.

OPPORTUNITIES

Our best picks at this point include Myriad Genetics (MYGN), Onyx Pharmaceuticals Inc.