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Top Growth Stocks Lead Sell-Off Amid Default Fear

Many of the year's best growth stocks fell sharply Tuesday as concerns about the government shutdown and looming debt ceiling deadline intensified.

Internet stocks were among the hardest hit. LinkedIn (LNKD) fell 6%, Facebook (FB) 7% and Netflix (NFLX) 5%. Yelp (YELP) sank 8%.

China-based Nets also tumbled, including Baidu (BIDU), Qihoo 360 Technology (QIHU) and YY Inc. (YY) "These are high-growth companies and when the perception of risks goes up these stocks don't do well," said Bill Whyman, analyst at International Strategy & Investment Group.

A partial government shutdown has entered a second week with nine days left to hike the nation's debt limit. President Obama on Tuesday again called on Republicans to fund the government and raise the debt ceiling. House GOP leaders reiterated that Obama should negotiate. Bottom line — neither side is budging.

Leaders In Retreat

Heavy selling was not limited to tech stocks, as other highfliers hit turbulence. Sprouts Farmers Market (SFM), which has the year's best first-day post-IPO gain, fell 6% Tuesday. It's down 11% since hitting a record high Friday. Jazz Pharmaceuticals (JAZZ) fell 6% and Valeant Pharmaceuticals (VRX) 4%.

The tech-heavy Nasdaq fell 2% while the S&P 500 fell 1.2%, both in heavy volume. With top-rated stocks leading the sell-off, the market is back in correction.

The declines come just as the earnings season gets under way. S&P 500 earnings as a whole are expected to be up 4.3%. Three months ago, the consensus was for a 8.5% gain.

S&P 500 companies have issued 94 negative EPS preannouncements for Q3 vs. 18 positive preannouncements, according to Thomson Reuters. This negative-to-positive ratio is above average but better than in Q2.

Scott Kessler, equity analyst at S&P Capital IQ, said despite Tuesday's sharp losses, growth stocks are still big winners year to date. Facebook is still up 77% in 2013. YY, which tumbled 15% Tuesday, has nearly tripled. The S&P 500 is up 16% this year.

"But when you see days like today, it causes people to reevaluate their strategy," he said.

"It's become increasingly apparent that the issues in Wash ington related to the government shutdown and debt ceiling indicate that these issues are not going to be resolved easily or quickly and could have a negative impact on economic growth," Kessler said. "That will have an adverse impact on some of these higher growth companies.

Whether the uncertainty in Washington will put the clamps on a hot market for initial public offerings is unclear.

There were 60 IPOs in Q3, more than double a year earlier. The quarter also boasted four of the year's five best first-day gains, including Sprouts' 123% advance on Aug. 1.

There have been 158 IPOs this year, already above last year's 128 and on track to be the most since at least 2007. Twitter last week detailed plans for a $1 billion IPO.

But the IPO window is highly sensitive to stock market performance. When the going gets tough, new issues disappear.

"It's not happening right now, but if the downward trend continues, the IPO market will get whacked," said Francis Gaskins, founder of IPOdesktop.com and director of research at Equities.com.

While IPOs might still flow, current trends could lead to lower pricings for new issues.

"We might see a pause while the underwriters reset prices for the current market," Gaskins said.