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S&P 500 Falls as Fed Valuation Concerns Overshadow Bank Earnings

July 15 (Bloomberg) -- 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 11 percent after Reynolds American Inc. reached agreement to buy its rival for $27.4 billion including debt. JPMorgan Chase & Co. and Goldman Sachs Group Inc. rose after the banks reported better-than-forecast earnings.

The S&P 500 fell 0.2 percent to 1,973.46 at 4 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 7 points, or less than 0.1 percent, to 17,062.42, buoyed by JPMorgan and Goldman Sachs.

“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 low in May 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 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.

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. 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.

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