2 Macro Catalysts That Could Tame The Bull Market

by: Quoth the Raven

Things have really been stacking up nicely for the bulls as of late. The past few years have yielded excellent results for investors that have chosen to buy and hold, and the bull market is now over three years strong and running. This article is to point out a "one-two punch" that could stop this bull dead in its tracks.

Once again, in the interest of disclosure, I'll admit up front that I've written a couple of articles on the bull run ending in the last couple of months.

On March 12, with the market sitting right around 14,500, I argued that for all intents and purposes, we were at the end of the bull market. Let the record show that I'm not necessarily wrong - yet -as the market has risen a little, but has been condensing steadily since then.

On April 16, I made the argument that the market is on the verge of panic. I still believe this to be true - the volatility and uncertainty during this latest two months has been bubbling under the surface so much so that it's palpable. I'll get into a bit more on the VIX later.

On July 25th, I contested that there has never been a better time to take your profitable positions from unrealized to realized than right now, a sentiment I'm sticking with right now.

Now, on August 7th, I'm noticing that we have a couple things coming down the pipe that this investor thinks could work together as catalysts to slow down, then reverse, the direction that the market is heading. Regardless of whether or not they do, it's important to know about both the Federal Reserve's plan, and the looming potential of a social media bubble.

Catalyst #1 - The Social Media Bubble

"The best minds of my generation are thinking about how to make people click ads. That sucks."

-Jeff Hammerbacher, former Facebook Employee

No sector has just blindly taken off with the furiousness that the social media sector has over the past couple of years. It has some stark similarities to the dot com boom in 2000; similarities that shouldn't be ignored. Names like LinkedIn (NYSE:LNKD), Yelp (NYSE:YELP) and Facebook (NASDAQ:FB) have been on a tear as of late, easily outperforming the market as a whole. Even smaller and less well known companies like Angie's List (NASDAQ:ANGI) and Groupon (NASDAQ:GRPN) have been outperforming the market significantly. We have gone crazy for our social media stocks, as this chart indicates:

Company 12 Month Performance Year-to-Date 3 Months
Facebook +87.0% +45.5% +44.1%
Yelp +100.9% +175.3% +69.2%
LinkedIn +116.4% +101.1% +27.8%
Angies List


+92.2% -0.7%

In addition, these companies are trading with somewhat astronomical price/earnings ratios, with LinkedIn leading this pack with a current P/E of 661.75. A commonly accepted P/E ratio for technology companies is generally around 20, which is dwarfed by all social media companies involved, as shown below:

(Click to enlarge)

There's been some arguments for the fact that the social media bubble is deflating, based on venture capitalists investing less in these companies of recent, but the push for Twitter to go public (which is all over the place today for some reason - it even popped up on my Facebook news feed as a CNBC.com poll) reaffirms that this bubble is still in play, and potentially about to welcome a new participant to the game.

You can combine these metrics with the fact that a lot of these startups do not use GAAP when reporting their earnings per share numbers. Bill Maurer does a perfect job pointing this out in his recent article, "The Social Media Bubble Continues to Bloat" (a great read to compliment this article, which I highly recommend perusing at your leisure):

For the social media names, almost all of them (Yelp is the only exception I believe) will have earnings per share numbers that are non-GAAP. What does this mean? Well, GAAP numbers are the actual financial numbers you will see in a 10-Q or 10-K filing. Many of these companies provide non-GAAP numbers, which exclude share-based compensation and some other adjustments in certain cases. Analyst estimates are usually based on the non-GAAP numbers. Non-GAAP numbers are generally going to be higher, making these companies either look more profitable than they really are, or profitable when they really are losing money.

Companies like Facebook and Yelp, both have relatively small short positions, both under 5% of their current float. Yelp, on the other hand, has always carried a significant short position, currently around 20% of the float. It's also likely to be a main contributor as to why Yelp skyrockets upwards when it moves. The question is going to lie in the timing of the short position for when it inevitably corrects, in my opinion.

I'd argue that the trend of going short companies like Facebook and LinkedIn hasn't' started to go mainstream yet, and we all know both bulls and bears will eventually have their day - that's how the market works. If these companies were the most to benefit during the bull market, they're likely to receive the biggest correction (read: ass whoopin') should the market pull back.

This leads me to another simple point. Regardless of what the catalyst is that pulls the market back, the fact that these companies are trading as such speculative prices makes them the first targets should something unexpected happen to drastically pull back the markets.

Erin McBride, blogger for The Motley Fool, echoes these sentiments in an article she wrote earlier this year, calling sites like LinkedIn "smoke and mirrors":

All social media sites need to be evaluated not just from the financial and money point of view, but also from the value the site brings to communication, social interaction, and business in general. A site may have a profitable advertising model, but that doesn't mean the site provides any value to its target audience. When the site audience stops visiting the site, the advertisers will jump ship for the next big thing.

LinkedIn falls under the category of "just might burst." It is one of the best examples ever of an overrated website. The company continues to make money (from an effective advertising and pay for premium business model) without any new advancements, technology, or offerings. And yet the stock continues to climb. This is baffling. What has the company actually done to keep its audience coming back? We saw this before in the dot com bubble burst. Good money went chasing after pretty promises on shiny websites, and it all disappeared overnight.

In Q3 2012 nearly 70% of LinkedIn's new users came from international markets, and nearly 63% of all LinkedIn users were international. However, international markets accounted for only 36% of total revenues. Some may say this means there is "significant opportunity to improve monetization." I say this is a sign that American advertisers are paying for a lot of spammers in India to send emails to Americans.

Is it time to jump into a short position in a company like Yelp or LinkedIn? I'd contend that it is. The only massive risk remains in the fact that these companies, because they're so overvalued, often move upwards without any rhyme or reason whatsoever. This type of major volatility can be considered as much of as risk as it can be considered a reason that these companies are so overvalued.

Catalyst #2 - The Federal Reserve & Volatility

Some have argued that this Fed taper is already priced into the market, but I don't necessarily agree with this. CNBC reported:

Wall Street is braced for the Federal Reserve to begin reducing the amount of its asset purchases as soon as the fall and believes that most-but not all-of the action is already priced into markets.

The 50 respondents to the July CNBC Fed Survey see the Fed reducing quantitative easing in October on average, compared with December in the prior survey.

The most popular response was September, chosen by 48 percent of respondents. On average, Wall Street expects the $85 billion of monthly purchases by the Fed to be reduced by $19 billion.

Although the banking sector (who's the most likely to show the effects first) doesn't seem to be responding to the taper right away, we still have the tapering to take place this fall.

Make no mistakes about it, the Fed is going to be the single biggest catalyst for how stocks in general perform in the upcoming year. The market over the past week has looked like it could be starting to spin its wheels in the midst of the Fed alluding to the fact that they're going to start tapering their bond buying as soon as this fall.

As I stated in a previous article, talking about a report that Barron's did on bull markets and the Federal Reserve:

He found that the market rises steeply before it dies, riskiest stocks shine before the market tops and that P/E ratios are an indicator of a market's top. It's a great read, I highly recommend going through the entire article.

Of late, we've gotten a couple of little nods in the bearish direction, even in the height of an earnings season that's generally been producing bullish results. We saw tech giants Google (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) miss earnings, Apple (NASDAQ:AAPL) engineer a decent earnings report, and banks allude to potential negative impact from interest rates in coming quarters.

As I've pointed out before, Bernanke's bull market is the 3rd strongest bull market in modern history. Bears contest the same thing that I've pointed out in previous articles; that this market is fueled solely by Bernanke at this point. What is going to happen when the Federal Reserve exits the party? The same people that were behind QE taking place, let's call them the "smart money" (not because they're ACTUALLY smart, but because they control the markets and have an inside horse) loaded up before hand and have made their money. Now, it's time for the smart money to make money heading in the other direction, and it's my contention that the smart money is going to follow Ben directly out the door.

How bout our good ole' friend, the VIX? He used to be all over CNBC, constantly screaming and whining and getting tons of media coverage for spiking all over the place. We haven't heard much about ole' VIX lately. What a cool, calm customer he has been for the last few years - staying out of the spotlight.

(Click to enlarge)

Any baseball fans here? Ever get that feeling that this one player that you're watching currently slump is "due" for a big hit? That's how I feel about the VIX, which has been slumping and hitting multi-year lows consistently over the past couple of years.

When Ben and the smart make their exit, it's going to be prime time for the VIX to be in the spotlight again.

How You Can Invest This

With these two events arguably coming down the pipeline sometime soon, the question is going to be how you can position yourself for gains, should this scenario occur.

To play the social media bubble, you can:

  • Short individual companies like LinkedIn, even while holding long positions in the companies that you think could make it through a bubble burst.
  • Invest in inverse technology ETFs like Short QQQ (NYSEARCA:PSQ), Ultrashort Technology (NYSEARCA:REW), or Daily Tech Bear (TYP)

To invest through the VIX:

  • Go long volatility ETFs, like VXX (note the contango associated with VXX, however)
  • Buy ETPs that track the VIX, like UVXY and CVOL
  • Buy VIX call options
  • Buy call options for VXV
  • Buy S&P VIX Mid-Term Futures VXZ
  • Buy S&P 500 VIX ETF listed as VIXS

In a previous article, I also offered up what a potential portfolio could look like for someone that thinks the Fed taper is going to cause a bullish reaction in the market:

  • Small 5%-10% long position in staple stocks [American Capital Agency Corp. (AGNC, NuStar Energy (NS), ACCO Brands (ACCO)
  • Medium sized position in actual gold or silver bullion
  • Medium sized cash position in FDIC insured account or in person
  • Small position in volatility ETFs and ETNs to be traded in the very short term
  • Small long positions in gold and silver trusts (GLD, SLV)
  • Medium sized long positions in inflation-adjusted Treasuries (AAA rated)

At the very least, I hope this article has offered up some perspective as to what could be a coming sea change for the markets. No matter what side of the coin you're on, QTR wishes all investors the best of luck going forward.

Disclosure: I 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.