After two years of positive, relatively calm results since the end of the 2008-2009 financial crisis, investors were once again reminded that uncertainty and fear can strike at any time. This time in the form of a 17 percent correction, which started quietly in May and culminated in a crazy and volatile first two weeks of August.
No one knows if the worst of this market correction is history. One sign, discussed in detail below, would seem to suggest that it is, but I believe the correct attitude for investors is to expect some additional volatility over the next month or two and be happy if it passes faster than that.
Some perspective on the recent correction seems to be in order. First, stock price corrections of 10 to 20 percent in up-trending markets tend to occur every couple years, so they should hardly be considered as rare or a surprise. In fact, we had a correction of very similar size in May and June 2010. Investors seem far more unnerved by the 2011 version, I suspect due to the very negative news environment dating back to the Japanese earthquake and tsunami in March, the resulting worldwide economic slowdown in the second quarter, as well as the fiscal battles here and in Europe so far in the third quarter.
This unnerving may have already caused the market to hit its bottom or perhaps be close. One indicator you may hear about if you go against my advice and watch television news coverage of financial markets is the Volatility Index (aka the VIX). VIX measures variations in options prices as short-term speculators attempt to trade or hedge bets using options contracts on the major indexes like the S&P 500 Index. In short, when fear is high the VIX rises, and when investors are confident and complacent, the index falls. Of course, this indicator should be taken as contrarian in nature. It is best to be fearful when others are greedy and greedy when others are fearful – a quote from Warren Buffett.
The usual range for the VIX during what we would call normal market action is between 15 and 25; with the extreme lows around 10 and the highest numbers ever recorded at about 100 during the 1987 market crash and at 80 during the height of the 2008 financial crisis.
Don't worry; there won't be a test on this later. What I would like for you to take away is that there have been nine times when the volatility index hit levels in the mid 40' or above, with Monday, Aug. 8, the latest, reaching a level of 48. In seven of the eight previous times the index reached the mid-40s or higher, it occurred very close to the low point for that correction. Often, the market didn't start a major recovery right away, but the low point was close to being established. The exception was the case of the 2008 financial crisis where the market did end up moving lower for a few months, with the recovery beginning in the spring of 2009.
In summary, volatility extremes normally occur at the end of corrections, not at the beginning. Based on a historical perspective, there is some evidence that we may have seen the worst of the current correction.
Another lesson we are reminded of would be that short-term price swings are unpredictable and the only really effective way to shield your investments from these surprise events is through diversification, with a leaning toward high quality fixed income investments for those who desire lower short-term fluctuation.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.