Selloff Spreads to S&P 500 as Stocks Fall Most in a Month

A three-day decline in Internet and small-cap stocks spread through the rest of the market yesterday, sending the Standard & Poor’s 500 Index to its biggest retreat in a month and pushing up options prices.

E*Trade Financial Corp., Urban Outfitters Inc. and Dow Chemical Co. lost more than 3 percent, leading the S&P 500 to a 0.9 percent drop. The Russell 2000 Index and Nasdaq Composite Index slid more than 0.6 percent. The Chicago Board Options Exchange Volatility Index rose 8.2 percent to 13.17, the most since April 10.

Reports this week showed an unexpected decline in U.S. industrial production and slowing retail sales, pushing down the S&P 500 two days after it briefly surpassed 1,900 and touched an all-time high. Some economists have blamed unusually harsh winter weather for a slowdown in U.S. growth this year. Broader indexes are increasingly getting dragged into a selloff that began two months ago in companies with the highest valuations.

“The markets are in a period of volatility right now, and it all has to do with growth being called into question,” Robert Pavlik, chief market strategist at Banyan Partners LLC, which manages $4.5 billion, said yesterday in a phone interview from New York. “The excuse that weather is driving down economic reports is a load of bull.”

Rally Stalled

After the biggest annual advance since 1997, returns in the S&P 500 have stalled amid concern that prices have outrun earnings. The U.S. equity benchmark is up 1.1 percent for the year. It trades at 17.2 times earnings, near the highest level since 2010, according to data compiled by Bloomberg.

Small caps and Internet shares have been the biggest losers in the market retreat. The Nasdaq Internet Index, which rallied almost 400 percent over the past five years to March, has since dropped 17 percent as concerns grew that valuations as high as 257 times estimated earnings for stocks such as Inc. and Pandora Media Inc. are too expensive.

The Russell 2000 has tumbled 9.3 percent from its March 4 record, while the S&P 500 is less than 2 percent from its peak. The small-cap gauge is heading for a ninth week of underperformance, the longest streak in 16 years. The S&P 500 rose less than 0.1 percent to 1,871.34 at 10 a.m. in New York, while the Russell 2000 was little changed at 1,095.10.

Holding Cash

David Tepper, founder of $20 billion hedge-fund firm Appaloosa Management LP, said he’s nervous about financial markets because the economy isn’t expanding at a sufficient pace. The money manager said that while investors can be optimistic on markets, they should hold some cash.

“We’ve been cutting back our exposure, or at least taking a long look and making sure we’re not overexposed to small caps,” Bruce McCain, who helps oversee more than $20 billion as chief investment strategist at the private-banking unit of KeyCorp in Cleveland, said in a phone interview. “We don’t think the valuation is as justified.”

Even though stocks are falling, this isn’t a good time to sell, according to Paul Zemsky, the New York-based head of multi-asset strategies at ING U.S. Investment Management. It’s impossible for most investors to pick the right moment to buy and sell shares and during the past two years, the market has quickly rebounded from any decline.

Not Selling

“I’m definitely not going to sell stocks here until my view of the economy really deteriorates, which it’s not at this point,” Zemsky said yesterday in a telephone interview. ING U.S. Investment Management oversees $200 billion. “Any time you’ve stepped out of the market with the intent to buy it lower, it’s been a very, very challenging thing to do.”

In the past year, the S&P 500 declined 4.8 percent from June 18 to June 24, slipped 5.8 percent from Jan. 15 to Feb. 3, and dropped 4 percent from April 2 to April 11. Each time, the index was above its previous high within five weeks of reaching the bottom.

Options, used by investors as a tool to protect the value of their stock holdings, have seen their cost increase amid speculation of further declines. CBOE’s Russell 2000 Volatility Index is up 13 percent this year to 19.85. A similar measure for the S&P 500 has dropped 4 percent.

The increase in volatility is leading investors such as Randy Bateman of Huntington Asset Advisors to use more options to hedge losses in equities. About 3.4 million options on the SPDR S&P 500 ETF Trust changed hands yesterday, almost 72 percent more than the 20-day average, according to data compiled by Bloomberg.

“The market had gotten too high and too stretched,” Bateman, who oversees $3.5 billion as chief investment officer of Huntington in Columbus, Ohio, said by phone. “There are a lot of people apprehensive of this market and options give them some predictability.”

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