Health care and biotech stocks enjoyed months as defensive investments of choice, but that ended in spectacular fashion in February. After a speech by President Barack Obama placed health care reform in the spotlight again, the sectors crashed along with the rest of the equities market.

"This was a major overreaction," says Brian Abrahams, senior biotechnology analyst for Oppenheimer. "It's mostly driven by sentiment and fear."

Until then, health care had remained fairly stable and was holding up better than most of the market, analysts say. Many believed health care reform would be pushed off the White House's agenda, as most of the nation viewed the overall domestic economy as job-one.

But the president's speech made his priority for health care reform all too clear and the market responded—negatively. "But fundamentals are solid," Abrahams argues. "We still think biotech is defensive. But the [market] sentiment is 'shoot first, ask questions later.'"

That's not to say the reaction isn't partially justified. Layoffs reduce the number of members paying into group health care plans, while continued unemployment cuts into individuals' ability to make COBRA payments. "There has been a decline in commercial enrollment as well as in self-funded plans," says Phillip Seligman, an equity analyst with Standard & Poor's. "And managed-care firms are seeing rising medical costs as a result of their premiums."

Still, earnings have held up in both the biotech and pharmaceutical sectors, says Steve Silver, an equity analyst who covers biotech for Standard & Poor's. "People still get sick and need to take medicine."

Like other employers, big pharma companies have taken protective measures, and made deep layoffs, to keep themselves afloat, Silver says. Some analysts also thought that bigger drug companies would snap up smaller biotech firms that have lucrative patent protections forbidding a new drug from being copied into a generic version. "There's still a belief in biotech that the innovations really warrant premium pricing," says Silver, who notes biotech's ability to boost giant drugmakers' bottom lines.

Indeed, recent deals illustrate this. Last month, Merck & Co. agreed to buy Schering-Plough for $41.1 billion; in January, Pfizer announced plans to acquire Wyeth for $68 billion; and Roche is trying to buy the part of Genentech that it doesn't already own.

The biggest fears were that investors would pull out of health care and biotech when the market sank further. But Abrahams says the real problem is what happens next. "My main concern is that large-cap biotechs will just trade sideways because generalists won't be willing to take the chance to come back."