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High-Flyer Stocks Finally Feel the Pull of DC’s Gravity

Michael Santoli

Just five days ago, a column in Investor's Business Daily, which focuses on finding stocks in strong uptrends, began like this: “The market may be under mild distribution, but leading growth stocks couldn't care less.”

This week, those anointed growth favorites started to care more.

A select group of high-momentum technology, consumer and biotech stocks, which have helped the Nasdaq build up a big lead on the broader market this year, succumbed Tuesday to some heavy selling pressure. The market’s slow grind lower amid the impasse in Washington over the budget and debt ceiling became a bit more intense and reaching some of the growth darlings.

The social-media stocks, driven skyward all year on fervent faith in their long-term potential to dominate advertising, were swamped. Facebook Inc. (FB) is off more than 9% since Monday’s close, having added an enormous $60 billion in market value since June. Yelp Inc. (YELP) is off nearly 15% over two days, and Chinese Internet leader Baidu Inc. (BIDU), which ran from $89 to $160 the prior three months, is off almost 10% to near $142.

The biotech group, which often operates free of broad economic developments to act as almost a pure barometer of speculative appetites, hit a huge air pocket. Some of the sector is moving on company-linked news, such as Ariad Pharmaceuticals Inc. (ARIA), which plunged more than 70% Wednesday, surrendering more than $2 billion in market value, after its key leukemia drug showed alarming levels of toxicity.

Yet the iShares Nasdaq Biotechnology (IBB) – representing a huge pool of market capitalization including all the industry bellwethers – is off 9% in 48 hours, dropping its year-to-date return to “only” 39%.

Finally, Tesla Motors Inc. (TSLA), the stock that nothing seemed able to slow down – including daunting valuation extremes and a hyped battery fire in one of its cars - has shed a quick 10%.

The modest market rebound midday Wednesday has stemmed these losses, but the charts of these stocks still show pretty stark reversals.

There are a few things going on here. Such momentum stocks require a steady, heavy flow of confident buyers to keep the stocks aloft, given little support from past profits or expected near-term financial results, in most cases. The exasperating standoff in Washington and the remote, but real, risk of technical government default has prompted traders to pull in risk across the board.

There’s another self-fulfilling element to the sharp pullbacks in these groups. One reason certain investors get attracted to such stocks and stay in them is the very fact that they kept going up, spurning every argument or excuse to retrace their gains. Once the “can’t-get-them-down” rationale is challenged by steep declines on heavy volume, it holds less sway.

It was common to hear that these growth “story stocks” offered a decent place for investors to “hide” amid macroeconomic, monetary and political threats, given that they are animated by abundant hope for their category-dominating potential in the very long term. The recent action implies this faith in their purported haven status is threatened, leading to understandable profit-taking given big gains.

No doubt pressure from fresh short sellers has come into play, as well, as traders position for a potential government-triggered washout and bet that the most expensive stocks with the most air underneath them would be hurt badly.

The implications of this clipping of the high-flyers for the broader market outlook aren’t entirely clear.

It tends to be a net positive, eventually, when investors stop clinging to the idea that there are easy places to find shelter from a general market setback and show more unease. If not always outright panic, then worry usually needs to precede a strong rebound. We’re getting there, though remain well shy of the level of anxiety shown in earlier politically plagued corrections. When the once-bulletproof leaders buckle, it can sometimes mean the fever has broken, so to speak, and it's closer to the end of a pullback than the beginning. This is only ever clear in retrospect.

As earnings season gets underway and likely serves as a welcome distraction to the D.C. standstill, it makes sense to watch for another emerging theme: the return to the fore of companies leveraged to the global growth cycle, rather than the domestic-focused or pure organic-growth stories.

Barclays Capital strategists point out that global-growth plays, such as big industrial companies and technology giants, are projected to show better earnings growth than less globally exposed firms for the first time in two-and-a-half years. The market has begun pricing some of this recovery in, as industrials have outperformed in recent months.

How the CEOs of these companies characterize the state of the tentative overseas rebound could determine whether the market might new leadership, after a long stretch in which the U.S. housing-and-auto recovery plays and a handful of cult growth stocks have arguably carried too much of the load.