The Market May Be Set For A Sell-Off

 |  Includes: NFLX
by: Vahan Janjigian, CFA

The much-delayed September employment report was released by the Bureau of Labor Statistics on Tuesday and the news was great. Great, that is, if you subscribe to the "bad news is good news" theory of investing. You see, the jobs report was actually bad. Nonfarm payrolls rose by only 148,000 in September, well below the 180,000 expectation. So why is this bad news great? Because it makes investors even more convinced that the Fed will have to delay any thoughts of tapering for even longer .

Investors have caught onto the Fed's tricks. They realize that the stock market hasn't been climbing the past few years because the economy is getting stronger. On the contrary, investors have learned that the market's rise is almost entirely due to the Fed and its program of quantitative easing (QE). And as long as the Fed was willing to pump out the QE, investors were willing to buy stocks.

Tuesday's action in the bond market was even more impressive than the rally in stocks. The yield on the 10-year Treasury dropped to 2.51%. Just one month ago, the 10-year was yielding 2.73%; and back in early September, when investors were convinced that tapering was about to begin, the yield momentarily broke above 3.0%. But then the Fed surprised the market. It apparently changed its mind and decided to continue with QE. Why did the Fed do this? Once again, it wasn't because the economy is doing well. On the contrary, the Fed chose to give us more easing precisely because the economy is doing badly. And Tuesday's employment report provided more evidence of this.

Most of us like to think that we live in a logical world; however, it seems that we actually live in an Orwellian world. A world in which bad is good. Investors know that the Fed will keep easing only if the economy is weak. And as long as the Fed keeps easing, stocks should go up. That's the logic, anyway. But a rally based on such convoluted thinking could suddenly backfire. One day investors might wake up and conclude that the Fed's efforts have caused a lot of asset-price inflation, but they haven't really done much to stimulate economic growth. That's when the selling might begin with earnest.

Perhaps Netflix's (NASDAQ:NFLX) Tuesday action suggests that a semblance of logic is coming back in vogue. Shares of NFLX rallied strongly in after-hours trading on Monday, immediately after the company announced better-than-expected results. This incredibly overvalued stock almost touched $400 per share. But on Tuesday, the shares plunged to $323. Of course, the sell-off in NFLX is being blamed on the news that Carl Icahn had already dumped about half his holdings. If Icahn-- considered to be one of the savviest investors around-- is selling, you can bet others will follow. And it's probably a good bet that NFLX won't be the only overvalued stock that gets hit.