Social Media Stocks Wobble Yet Again After Fed Valuation Warning

Internet and biotechnology stocks, at the center of almost every volatility scare the U.S. stock market has seen in an otherwise calm 2014, were back in the lurch yesterday.

Valuations for smaller biotechnology and social media stocks are stretched, the Federal Reserve said in its Monetary Policy Report delivered to Congress yesterday. The Russell 2000 Index of small-cap shares sank 1 percent, closing at the lowest level almost six weeks. The Nasdaq Biotechnology Index lost 2.3 percent and the Global X Social Media Index exchange-traded fund retreated 1.1 percent.

Smaller technology stocks command some of the highest valuations in the market amid investor demand for companies with the potential to boost profit in a sluggish economy. Concern that earnings at biotechnology, Internet and small-cap companies dont justify their share prices made the industries the biggest losers in a market retreat earlier this year.

A lot of people are blaming the Fed, but with valuations this high you dont need an excuse to sell, Eric Cinnamond, manager of the $724 million Aston/River Road Independent Value Fund, said in a phone interview yesterday from Louisville, Kentucky. Small-caps are being priced as if were on this growth trajectory thats not quite there. Theyre priced for fantasy land.

The Standard & Poors Smallcap 600 Index trades at 26 times reported profit, while 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 most expensive valuation since 2010.

The ETF tracking social-media shares fell after rising 1.3 percent July 14, with losses exceeding 2.5 percent in Yelp Inc. and Zynga Inc. Facebook Inc. (FB), which trades at 90 times earnings, slid 1.1 percent to $67.17 after two trading days with gains of more than 2 percent.

Equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched, with ratios of prices to forward earnings remaining high relative to historical norms, the Fed said in the report.

Its unusual for the central bank to give specific commentary about industries in the equity market, said Paul Zemsky, head of multi asset strategies at Voya Investment Management LLC.

The market just got spooked with the mention of biotechnology and social media stocks, Zemsky said by phone yesterday in New York. Voya oversees $213 billion. Were 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.

Officials have made broader cautionary statements about valuations for smaller companies this year. In February, Fed Governor Daniel Tarullo said the surge in small-caps was one reason policy makers should ensure they werent creating systemic risk in financial markets.

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Social Media Stocks Wobble Yet Again After Fed Valuation Warning