S&P 500 Falls as Fed Valuation Concerns Overshadow Banks

The Standard & Poor’s 500 Index fell, following yesterday’s rebound, as Federal Reserve concerns about valuations among social-media and biotech companies overshadowed better-than-estimated bank earnings.

The Dow Jones Internet Composite Index slumped 0.7 percent and the Nasdaq Biotechnology Index lost 2.3 percent. Lorillard Inc. dropped 10 percent after Reynolds American Inc. reached an agreement to buy its rival for about $25 billion. JPMorgan Chase & Co. and Goldman Sachs Group Inc. rose after the banks reported better-than-forecast earnings. Intel Corp. jumped 4.5 percent after the market closed as it reported results.

The S&P 500 fell 0.2 percent to 1,973.28 at 4:25 p.m. in New York, after rebounding yesterday from the worst week since April. The Russell 2000 Index of smaller companies slumped 1 percent. The Dow Jones Industrial Average rose 5.26 points, or less than 0.1 percent, to 17,060.68, buoyed by JPMorgan and Goldman Sachs. More than 6 billion shares changed hands on U.S. exchanges today, 4.8 percent above the three-month average.

“The Fed wants to pay attention to valuations given that they might have to change the interest rate backdrop that has been a strong catalyst for the market,” Eric Teal, who helps oversee about $3.6 billion as the chief investment officer at First Citizens BancShares Inc. in Raleigh, North Carolina, said by phone. “The small cap area is going to be much more interest-rate sensitive.”

Small-caps and Internet shares were the biggest victims of a market retreat earlier this year as investors dumped the best performers of the bull market amid concern valuations advanced too far. The Russell 2000 climbed back from a May low to within a point of its all-time high on July 3. Selling in Internet and biotech shares resumed last week, sending the Russell 2000 to a loss of 4 percent, its biggest weekly decline in two years.

Small Caps

The S&P 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.

“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.

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.

Fed Minutes

Minutes from the Fed’s June meeting, released last week, showed some 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.

The central bank must press on with monetary stimulus as “significant slack” remains in labor markets and inflation is still below the Fed’s goal, Fed Chair Janet Yellen said in semi-annual testimony prepared for delivery to the Senate Banking Committee.

Yellen cited labor-market weaknesses even after an unexpectedly fast decline in unemployment put pressure on Fed officials to consider accelerating their timetable for an interest-rate increase. Yellen said today that rates are likely to stay low for a “considerable period” after bond purchases end, which she said could happen following the Fed’s October meeting.

Economic Data

Three rounds of Fed bond-buying have helped propel the S&P 500 higher by more than 190 percent during the current five-year bull market. The gauge has rallied 6.8 percent this year amid signs the U.S. economy is recovering from a 2.9 percent contraction in the first quarter.

Equities advanced earlier today as retail sales showed a broad-based gain in June, which probably helped the U.S. economy rebound in the second quarter. Separate data showed the Fed Bank of New York’s general economic index rose to 25.60 in July, above estimates for a reading of 17. Positive readings signal expansion in New York, northern New Jersey and southern Connecticut.

The S&P 500 closed at an all-time high and the Dow topped 17,000 for the first time on July 3. The S&P 500 hasn’t had a drop of 10 percent in more than two years.

The Chicago Board Options Exchange Volatility Index rose 1.2 percent to 11.96. The gauge known as the VIX jumped 17 percent last week for its biggest rally in three months, after closing July 3 at the lowest since 2007.

Six out of 10 main industries in the S&P 500 dropped, with health-care and consumer-staple shares losing at least 0.8 percent for the largest declines.

Internet Stocks

The Dow Jones Internet index slid 0.7 percent. The gauge had rallied 15 percent from a low on May 8 to erase its losses for the year before falling 3.2 percent last week. The barometer surged 54 percent in 2013.

Pandora Media Inc., which trades at more than 160 times projected earnings, fell 1.2 percent. Facebook Inc. and TripAdvisor Inc., which rallied more than 98 percent in 2013, lost at least 1 percent.

The Nasdaq Biotechnology index slid 2.3 percent, after falling 3.2 percent last week, the most since April 11. It had rallied as much as 23 percent since a low that month.

Lorillard slid 10 percent to $60.17 and Reynolds American slumped 6.9 percent to $58.84. The deal will reduce the 400-year-old U.S. tobacco industry to two major competitors.

Tobacco Consolidation

After decades of anti-tobacco health campaigns, slumping demand has put pressure on the industry to consolidate. U.S. cigarette shipments fell by a median of 2.9 percent in the first quarter among the nation’s top tobacco companies, according to data compiled by Bloomberg Industries. Merging Reynolds and Lorillard would help the companies cope with the slowdown and create a more potent competitor to market leader Altria Inc.

Financial companies had the biggest advance as a group in the S&P 500, gaining 0.7 percent.

JPMorgan rose 3.5 percent to $58.27. The biggest U.S. bank by assets posted second-quarter profit that beat estimates as fixed-income trading revenue fell less than analysts expected.

Goldman Sachs, which set a Wall Street record for trading revenue in 2009, added 1.3 percent to $169.17. The bank reported a surprise increase in second-quarter profit as fixed-income revenue fell less than many analysts projected and investment-banking fees rose.

Bank Earnings

Banks have seen profits hurt in recent quarters as the Fed slows its bond buying and fixed-income clients make fewer bets amid low volatility.

Wells Fargo & Co., the most valuable U.S. bank, posted second-quarter profit last week that rose 3.8 percent on lower credit costs, while Citigroup said yesterday that net income fell 96 percent as the company agreed to pay $7 billion to resolve a mortgage-related probe. Bank of America Corp., the second-biggest U.S. lender by assets, is scheduled to report results tomorrow.

Johnson & Johnson fell 2 percent to $103.28 for the biggest drop in the Dow. The pharmaceutical and consumer goods manufacturer boosted its 2014 earnings estimates for the second quarter in a row.

The new forecast, though, reflected only a strong quarter rather than future strength, said Danielle Antalffy of Leerink Research. She said the share decline may reflect “the lack of a more meaningful guidance raise to reflect this quarter’s outperformance.”

Plug Power

Some 58 companies on the S&P 500 post earnings this week. Profit for the gauge’s members increased 4.5 percent in the second quarter, and revenue rose 3.1 percent, according to estimates compiled by Bloomberg.

Intel climbed 4.5 percent as of 4:57 p.m. in New York. After the close or regular trading, the world’s biggest maker of semiconductors forecast third-quarter sales that topped some analysts’ predictions, fueling optimism for a stronger rebound in the personal-computer market.

Plug Power Inc. jumped 16 percent to $4.85 during regular trading. FBR Capital Markets began coverage on the developer of fuel-cell systems with an outperform rating, similar to a buy recommendation, with a price estimate of $8 on the shares.

GoPro Inc. climbed 13 percent to $41.63. JMP Securities LLP started coverage of the company, whose cameras let surfers, skiers and sky divers record their exploits, with a rating of market perform, similar to a buy recommendation.

Lions Gate Entertainment Corp. rose 3.3 percent to $29.67. The developer and distributor of film entertainment content and Alibaba Group Holding Ltd. announced an agreement to stream Hollywood movies and television shows as China’s biggest e-commerce operator expands its video content.

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