Bracing for a Market Pullback

By Markets

Everyone’s familiar with the credo of Berkshire Hathaways Warren Buffett: “Be fearful when others are greedy, and be greedy when others are fearful.” Well, lately it seems investors have been awfully greedy. The Dow is up almost 19% in the past six months, enjoying a consistent climb since mid-December.

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But markets never climb in a straight line forever. Inevitably, there will be a pullback.  And there are plenty of signs one might be here soon.

This content was originally published on InvestorPlace.

For example, hedge fund manager Doug Kass — who tends to be spot-on with market predictions — recently went bearish. Some of the risks he sees include the persistently high oil prices, geopolitical problems in the Middle East and slowdown in China. He also points out that there has been a divergence between the S&P 500 and the Dow Transports, which has lagged. This tends to foretell a pullback at some point in the broad market, which he says could be 4% to 5%.

Plus, a look at the S&P 500 shows that while the index might eventually clear the 1,360 resistance mark that’s been so much trouble, again, a pullback is in order.

But a pullback doesn’t mean losses for all investors. Traders willing to accept some risk can take short positions and make money when things take a turn for the worse. Here’s a few shorts investors should consider:

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Groupon

A rule of thumb for an IPO is that its first earnings report needs to beat expectations. Otherwise, investors who made an initial bet on the company are likely to take a hit.

Unfortunately for shareholders in Groupon (GRPN), the company whiffed big on its first quarterly earnings report. The company’s revenues were up almost 200%, but the company still lost almost $43 million. Groupon has massive scale and employs more than 10,000 people, but can’t seem to get profitable. There’s questions about its business model, and the company has been lowering its marketing costs, which could mean a reduction in revenues. All the meanwhile, it has to deal with tough rivals like Google (GOOG) and LivingSocial.

Sentiment is low on Groupon, and it could fall on a weak market.

Apple

It might seem absolutely insane to even consider shorting Apple (AAPL). But it’s not like the company hasn’t seen its stock drop before.

Besides, how many bulls can there be? Already, Apple stock has gone parabolic, which can be an ominous sign. This was the case with companies like Microsoft (MSFT), which, a decade ago, was expected to be the first company to reach $1 trillion in value.

If the market turns back, investors already greatly rewarded by Apple will be tempted to take their profits. And things could get worse if the iPad 3 underwhelms.

Amazon

InvestorPlace Editor Jeff Reeves previously put Amazon (AMZN) on his list of top shorts for 2012. True, the company is the dominant player in e-commerce and is taking market share away from brick-and-mortar companies like Wal-Mart (WMT) and Best Buy (BBY). And yes, Amazon’s Kindle Fire tablet is a great product that will be pivotal in its fight to remain relevant in the mobile market.

So what’s Amazon’s problem? Well, the company does not have much consideration for the costs of these investments. Amazon had a lackluster performance in its fourth-quarter earnings report, with earnings of $177 million (38 cents per share) and revenues of $17.4 billion coming in below Street estimates. The company also provided tepid guidance for the current quarter, saying it could even sustain a loss. Amazon investors’ patience might be wearing thin, and it could break on a pullback.

Tech Stocks

Of course, tech stocks as a whole have been among the biggest winners in the recent rally. But in a pullback, the sector likely will be one of the biggest victims of profit-taking.

A way to play negative with the whole group is to short the Select Sector Technology SPDR (XLK). It focuses on large-cap stocks and is fairly concentrated, with the top 10 holdings accounting for nearly 65% of the portfolio. Or you could consider entering a short ETF like the ProShares UltraShort Technology (REW) fund, which is built to gain when the Dow Jones U.S. Technology Index drops.

Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook, All About Short Selling and All About Commodities. 

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