How To Play The Fed Turn

Higher interest rates can negatively impact biotech stocks through several mechanisms:

Increased Cost of Capital: Biotech companies, especially smaller or early-stage firms, often rely heavily on borrowing to fund their research and development (R&D) activities. Higher interest rates increase the cost of borrowing, making it more expensive for these companies to finance their operations. This can lead to reduced profitability and slower growth, which can lower stock prices.

Reduced Present Value of Future Earnings: The valuation of biotech companies is often based on the potential future earnings from their products. Higher interest rates increase the discount rate used in discounted cash flow (DCF) models, which decreases the present value of expected future cash flows. As a result, the perceived value of these companies' future profits drops, leading to lower stock prices.

Shift to Lower-Risk Investments: Higher interest rates can make fixed-income investments like bonds more attractive compared to stocks, particularly those perceived as riskier, such as biotech stocks. As investors seek safer returns, they might move their money out of biotech stocks and into bonds, causing biotech stock prices to fall due to decreased demand.

Overall, the combination of higher borrowing costs, reduced attractiveness of future earnings, a shift in investor preference towards safer assets, and potential economic slowdown contribute to the decline in biotech stock prices when interest rates rise.