What the Fear Gauge Says
The volatility index, climbing until Greece’s vote SundayĂ‚Â favoring the pro-austerity party, is back down. Popularly known as the fearĂ‚Â index, it roughly measures investors’ anxieties. When it climbs, it’s a bearishĂ‚Â signal. But look for the index to rise again.
The troubles in Greece – and Europe – are far from over. EuropeĂ‚Â will go through what we went through after 2008. The U.S. economy is still notĂ‚Â healthy, and China is only starting the downward trend.
After Sunday’s vote, the Standard & Poor’s 500 increasedĂ‚Â 1.13% in two days. It is up 7.98% in price terms this year. At first blush,Ă‚Â things are looking good and every technician is bullish (short-term to be fair).Ă‚Â Yes, short term it looks good, but at what risk?
That’s where the volatility index comes in. The Chicago BoardĂ‚Â Options Exchange Volatility Index, or VIX, had advanced from May’s annualizedĂ‚Â 12.5 to last week’s 21, a worrisome uptrend. Today it closed 18.38, up 0.33%.Ă‚Â The VIX employs options on the S&P 500 to gauge expectations for futureĂ‚Â swings for that market benchmark.
It seems that the entire market is trading on the news fromĂ‚Â Europe. It used to be that when the U.S. economy sneezed, the rest of the worldĂ‚Â caught cold. Things have certainly reversed, for the time being, and the marketsĂ‚Â are driven by how bad or less bad the news from Europe is.
Focus on the U.S. sectorsĂ‚Â whose valuations are based solidly on fundamental value, for the next three toĂ‚Â six months. We will recover sooner than later. Europe is important, but it willĂ‚Â only bring news-based trading, which will increase volatility
My firm started itsĂ‚Â portfolio allocation this month with mostly defensive positions, using
exchange-traded funds from State Street Advisors that represent S&P 500Ă‚Â 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 wereĂ‚Â short the other six S&P 500 economic sectors: Discretionary (XLY), EnergyĂ‚Â (XLE), Financials (XLF), Industrials (XLI), Materials (XLB) and TechnologyĂ‚Â (XLK).
Although we believe theĂ‚Â market is still trading on fear rather than on fundamental value, we see someĂ‚Â signs of the U.S. investors breaking through the scare of the European news andĂ‚Â 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 longĂ‚Â portfolio.
Too much of this month’sĂ‚Â positive return is based on Greece. This is not a way to invest long term. EvenĂ‚Â if they form a functioning government and stay in euro, we saw this movie overĂ‚Â 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 willĂ‚Â 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.