What the Fear Gauge Says

The volatility index, climbing until Greece’s vote Sunday  favoring the pro-austerity party, is back down. Popularly known as the fear  index, it roughly measures investors’ anxieties. When it climbs, it’s a bearish  signal. But look for the index to rise again.

The troubles in Greece – and Europe – are far from over. Europe  will go through what we went through after 2008. The U.S. economy is still not  healthy, and China is only starting the downward trend.

After Sunday’s vote, the Standard & Poor’s 500 increased  1.13% in two days. It is up 7.98% in price terms this year. At first blush,  things are looking good and every technician is bullish (short-term to be fair).  Yes, short term it looks good, but at what risk?

That’s where the volatility index comes in. The Chicago Board  Options Exchange Volatility Index, or VIX, had advanced from May’s annualized  12.5 to last week’s 21, a worrisome uptrend. Today it closed 18.38, up 0.33%.  The VIX employs options on the S&P 500 to gauge expectations for future  swings for that market benchmark.

It seems that the entire market is trading on the news from  Europe. It used to be that when the U.S. economy sneezed, the rest of the world  caught cold. Things have certainly reversed, for the time being, and the markets  are driven by how bad or less bad the news from Europe is.

 

Focus on the U.S. sectors  whose valuations are based solidly on fundamental value, for the next three to  six months. We will recover sooner than later. Europe is important, but it will  only bring news-based trading, which will increase volatility

 

My firm started its  portfolio allocation this month with mostly defensive positions, using
exchange-traded funds from State Street Advisors that represent S&P 500  sectors. As June began, we were long with Health Care Select SPDR (XLV), Staples (XLP) and Utilities (XLU). For our long-short portfolio, that means that we were  short the other six S&P 500 economic sectors: Discretionary (XLY), Energy  (XLE), Financials (XLF), Industrials (XLI), Materials (XLB) and Technology  (XLK).

 

Although we believe the  market is still trading on fear rather than on fundamental value, we see some  signs of the U.S. investors breaking through the scare of the European news and  focusing on the actual fundamentals of the nation’s economy. In the first week
of the month, we switched the Materials and Technology ETFs to our long  portfolio.

 

Too much of this month’s  positive return is based on Greece. This is not a way to invest long term. Even  if they form a functioning government and stay in euro, we saw this movie over  past several months already. One vote does not make policy in Greece. Spain’s
trouble is real and large, and Italy is waiting for its turn. Let’s hope it will  not go that badly in the end.

 

At the time of publication, Rockledge clients had long and short positions
in SPY, XLB, XLE, XLF, XLI, XLK, XLP, XLU, XLV and XLY in some portfolios.