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Biotech, Internet Stocks Fall as Fed Cites High Valuation

Biotechnology and social media stocks slumped as the Federal Reserve said valuations in smaller companies in the industries are “substantially stretched.”

The Nasdaq Biotechnology Index retreated 2.3 percent, the most in a week, and the Global X Social Media Index ETF lost 1.1 percent as of 4 p.m. in New York. Facebook Inc. and Pandora Media Inc. slid more than 1 percent. The Russell 2000 Index of small-cap shares fell 1 percent.

“The market just got spooked with the mention” of biotechnology and social media stocks, Paul Zemsky, the New York-based head of multi-asset strategies at Voya Investment Management LLC, which oversees $213 billion, said by phone. “We’re in a new era of macro policy where the Fed is using new tools to prevent bubbles and raising vocal concerns when markets are away from fundamentals.”

Fed officials have made cautionary statements about valuations for smaller companies already this year. In February, Fed Governor Daniel Tarullo said surging small caps were one reason policy makers should ensure they weren’t creating systemic risk in financial markets.

The Standard & Poor’s Smallcap 600 Index trades at 26 times reported profit and the Nasdaq Biotechnology Index has a multiple of more than 500, according to data compiled by Bloomberg. The broader S&P 500 has a price-earnings ratio of 18, the highest level since 2010.

Substantially Stretched

“Valuation metrics in some sectors do appear substantially stretched, particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year,” the Fed said in a policy report today.

Concern about valuations in Internet and biotechnology shares trigged losses in the stock market earlier this year, leading the Nasdaq biotechnology gauge to drop 21 percent between February and April. The index has since recovered most of those losses amid optimism about the economy.

Minutes of the Fed’s June meeting showed some Fed policy makers were concerned investors may be growing too complacent about the economic outlook and the central bank should be on the lookout for excessive risk-taking.

“Following the financial meltdown, the Fed has recognized that it needs to broaden its scope of factors affecting financial health and stability,” Alan Gayle, senior investment strategist, who helps oversee about $50 billion for RidgeWorth Investments, said by phone from Atlanta. “This seems to be new ground for the Fed trying to parse details on various sectors.”

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