Jeff Reeves's Strength in Numbers: Here’s why the market’s ‘fear gauge’ can be a strong signal to buy

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It seems the only thing investors talk about these days is volatility.

The “V-word” has been front and center in headlines for about a week now. Yes, the CBOE Volatility Index, or “VIX”












VIX, -3.42%










  spiked more than 40% in just a few days. And yes, Bloomberg reported that Barclays Bank PLC iPath S&P 500 VIX Short-Term Futures ETN












VXX, -0.46%










  actually recorded more trading volume on Tuesday than any of the major corporations in the S&P 500












SPX, -0.06%










 , trading a record 110 million shares.

But for all the chatter about dreaded market volatility, there seems to be a major deficiency in context. Why is it that short-term volatility in the market is now universally bad? And how does it predict long-term troubles for investors?

A closer look at market history — and market volatility — shows that the recent gyrations are not cause for conniptions. Contrary to popular belief and headlines, volatility simply is not a problem.

The most amusing thing about all the volatility hype lately is that it frequently ignores the fact that the recent “spike” in the VIX isn’t even in the ballpark of the 52-week high of the so-called “fear gauge.” The VIX, currently around 17, topped 30 as recently as February 11 during a choppy start to the year.

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So why the doom and gloom about the recent surge in the index, if it’s not even the “worst” of the year?

More important to investors than previous movements in the VIX, however, is how their stocks perform around the time of these upward moves in the fear index. A few recent time periods show that short-lived spikes in volatility have actually been a great opportunity to buy. Consider the following:

June 2016:: The VIX spiked to about 26 or so in late June after the Brexit vote. 30 days later, the S&P 500 was up about 4%; the S&P 500 is up almost 5% from that June peak so far.

February 2016: The U.S. market was volatile at the start of the year; after the VIX spiked in mid-February the S&P 500 tacked on 9% in the next 30 days. Stocks are up about 13% since then.

September 2015: The VIX spiked twice in September 2015, touching a six-and-a-half year high as the Fed contemplated a rate increase. Sound familiar? Well, after the surge in the fear index at the end of September 2015, the S&P 500 rallied by double-digits in the next 30 days. Since then the index is up about 13% in total.

Low volatility vs. low risk

Part of why investors associate such trouble with the V-word is because there has been a heavy marketing push lately for so-called smart beta strategies that purport to lower your portfolio’s volatility. That means marketing departments in the ETF industry have a vested interest in making volatility a bad thing, because then you will be more inclined to buy their products as a solution.

Typically, a low-volatility ETF will take an index and tweak it — perhaps making it equal weight instead of market-cap weighted, or by focusing on low-beta companies. The goal of these funds (and their marketing departments) is to convince you that low-volatility investments are low risk.

Low-volatility marketing in no way means that the underlying investments are somehow low risk. Case in point: Dominion Resources












D, +0.37%










  may have a low beta and fit the description of a low volatility investment for some. But do you honestly think a no-growth utility stock with a forward P/E of 19 and a 60-day return of -5% is without its own unique risks?

Also, consider a recent article by MarketWatch contributor John Coumarianos, which showed the top holdings of the iShares Edge MSCI Minimum Volatility ETF












USMV, -0.13%










  still declined sharply during the 2008 financial crisis — including a gut-wrenching 54% decline for one of the ETF’s top holdings, megacap insurer UnitedHealth Group












UNH, -0.19%










 

That said, stable dividend payers are good foundational investments for any portfolio, and particularly in the current market environment. But it’s worth remembering that there is no such thing as a risk-free return in the stock market — even for funds that purport to be low in volatility.

Keep this in mind the next time you see a headline about a spike in the VIX, and consider running to the latest fashionable investment that promises safety.



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