Mr. Market Could Be Pricing In A Recession

by: Nikhil Gupta

Summary

Overvalued stocks are being battered and bruised on poor results or weak forecasts.

Wall Street could be preparing for a recession as it punishes non-performing stocks.

Long-term value investors should consider investing in bargain stocks.

Friday was a terrible day for US stocks, specifically technology stocks. The massive sell-off was led by a frightening 44% crash in LinkedIn (NYSE: LNKD) which pulled down even giants such as Facebook (NASDAQ: FB) and Alphabet (NASDAQ: GOOG). Technology index NASDAQ closed the day 3.25% lower at 4363.14 points, its lowest closing level since November 2014.

The reason why I mention closing level is purely technical in nature. I want to suggest here that amid all the big swings, it is the bears who are winning the battle.

I have two theories regarding the current market rout. One is that Mr. Market could be pricing in a global recession in the next 12 months. Second, that Wall Street is finally coming to its senses and pulling down the stocks from their stratospheric valuations. And we know for sure that technology is the most overbought sector.

A Global Recession On The Horizon?

Recently, I read an article on MarketWatch which said that CEOs and top executives were confident that the probability of US diving into a recession is low. I think the Market is not buying their words.

The way investors are dumping their holdings in stocks expecting a weak quarter ahead, or providing weak full-year revenue or profit projections tell of a graver scenario for the US economy.

As it becomes more probable that the US Fed will adopt a wait-and-watch approach before hiking interest rates again in 2016, the banking stocks have been hit badly. They lose out on their billions of dollars of interest income, which was due to flow in on account of higher interest rates. Another thing that is haunting the banking stocks is their exposure to the energy companies. Although a clear number is still not available, it is estimated that tens of billions of dollars are tied up in energy loans. Not very significant considering the trillion-dollar banking sector but enough to cause ripples and scare.

So yes, banking and energy stocks have been battered. Automobile sector is also witnessing turbulent times. And with the most sought-after (and the most speculative) sector i.e. the technology sector doling out bleak forecasts, the Market is likely pricing in a recessionary scenario.

Market Is Finally Coming To Its Senses

Another theory which I have regarding the current decline is that Mr. Market is finally coming to its senses and treating the stocks as they should have been rationally. The US market had not had a decent correction since 2009 and pushed stocks to extremely overheated valuations. The day of reckoning seems finally here, and stocks are being pulled to meet their reasonable levels. Although the technology and the biotech sector needs to depreciate significantly to meet investment criteria, but that is just my opinion.

The way Wall Street has irrationally buoyed stocks with no earnings, and in some cases, no long-term potential, is a perfect case-study. And investors need to wake-up to the reality before their dreams turn into unforgettable nightmares. We have seen that happen before, and it cannot be ruled out even now. This time is not different!

Mr. Market is acting like 'The Punisher' who will no longer tolerate any misses. Take for instance, LinkedIn, Lions Gate (NYSE: LGF) and Tableau Software, Inc. (NYSE: DATA) which witnessed massive losses of 44%, 27% and 49% respectively as they shared soft projections or missed on street estimates.

Timely corrections make for a stronger bull market. But investors often over-estimate the true potential of a company, catapulting it to billion-dollar valuations in the anticipation of unknown profits in an unknown number of years into the future. This irrational behavior often causes a bubble, such as the recent tech bubble, which never ends well. I see a similar case in Salesforce.com (NYSE: CRM), and believe that 2016 will be the year that investors run out of patience with one of the hottest tech stocks. You can read about it here.

Market Volatility Could Be An Opportunity As Well!

I find it very hard to figure out the scenario for the next 2 quarters, leave alone for the entire 2016. With a lot of thing going on in the market, it is tough to ascertain what will unravel in global stock markets in 2016. My personal opinion is that Nasdaq tumbles another 10% to 4000-4100 range before we see a good, strong rebound.

However, amid all this, long-term value buyers should look to add to their portfolios attractively-priced stocks. Prudent would be to invest from a minimum of 3-5 years' perspective into bargain stocks and not blindly pouring money in hot names.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Market participants should complete their due diligence before making an investment decision. The points provided here are a personal opinion, and should not be construed as investment advice.