Equity capital market performance in 2015 has been a bit of a roller coaster ride. In January, markets were down from the previous month with the S&P 500 down 3.1%, the Dow Jones Industrial Average (DJIA) down 3.7% and the Russell 2000 down 3.2%. Performance improved in February with the S&P 500, DJIA and Russell 2000 all rebounding between 5-6%.

Recent economic factors have helped push the markets higher. Most public companies reported strong earnings for the quarter ending December 31, 2014. These solid corporate earnings and the recent strength of crude oil contributed to the positive February equity market performance. In addition, the European central bank announced an approximately €1 trillion quantitative easing/stimulus program. This has provided confidence to some that Europe will move away from a recessionary and deflationary environment.

But as companies and investors look to the rest of the year, the big lingering question is: when will the U.S. Federal Reserve begin raising interest rates? Some market watchers believe the rate increase may come in June 2015. Others believe it may occur in September or later.

Bruce Bittles, chief investment strategist at Robert W. Baird & Co. (Baird), commented March 9, “The financial markets are being negatively impacted by uncertainty surrounding the Fed’s indecision on rates and excessive investor optimism. The economy and labor markets are improving, which is pressuring the Fed to move away from the seven-year policy of zero percent interest rates. The rally in the U.S. dollar, on the other hand, to an 11-year high against a basket of currencies, is causing the Fed to hesitate.” 
This uncertainty concerning the Federal Reserve’s decision is causing close scrutiny of near-term economic indicators and their impact on the capital markets.

The recent market volatility and speculation on the Federal Reserve’s actions are an overhang on new equity issue activity. In January and February of this year, there were 22 total initial public offerings (IPOs)  versus an average of over 22 per month in 2014. The 2014 IPOs—as an asset class—performed very well for investors. As a group, they nearly doubled the performance of the broader market, returning on average 21.8%compared to 11.4% for the S&P 500.

With regard to follow-on equity offerings, activity has continued to be strong in 2015, with 125 total issuances¹ pricing in January and February. In 2014 the average number of follow-on offerings monthly was approximately 56, comparable to the January and February 2015 volume. The IPO and follow-on offering activity in January and February 2015 occurred even as approximately a net $3.5 billion flowed out of equity mutual funds  during the first two months of the year.

Within all of this equity capital markets activity, the Healthcare sector has been a particularly bright spot with over 47% of all IPOs and Follow-on offerings in January and February 2015. A significant contributor to this activity is the biopharma sector. Outsourced pharma services companies, including CROs, have benefited, both directly and indirectly. Dating back to 2012, CROs have significantly outperformed the S&P 500.

This strong performance has been driven by a combination of factors including the growth of R&D spending, the steadily increasing portion of R&D work that is outsourced to CROs and the favorable funding environment for biopharma sponsors. Eric Coldwell, senior equity research analyst at Baird, commented, “Recent strong biotech financing, and improved drug approval profile for large pharma, and a relatively stable economy and regulatory environment bode well for CROs. And despite what appear to be a modest slowing of new business activity for the group, we continue to believe that clinical CROs are in the middle innings of a cyclical recovery.”

Evidence is the new business win activity from 4Q14, during which the publicly traded CRO group reported a 1.39x net book-to-bill ratio, the strongest since 1Q12.

While not immune from macroeconomic influences, the outsourced pharma services and IT sector is well-positioned to continue benefiting from the current favorable operating environment. Last year saw a 10-year high for new drugs approved by the FDA. In addition, the combination of modest R&D spending growth and increased outsourcing from sponsors is expected to continue creating tailwinds for the sector. 

References

1. Baird Market and Investment Strategy, Weekly Market Notes, “Dollar Strength a Headwind for Economy and Stocks,” March 9, 2015.
2. Includes offerings greater than $15 million.
3. Excludes Exchange Traded Funds (ETF).
4. Baird Equity Research Report “Quintiles Transnational Holdings (Q) – CRO Bellwether Set up for Strong 2015”, dated Feb. 12, 2015.
5. Includes CRL, CVD, ICLR, INCR, PRXL, PRAH and Q.