Friday, June 04, 2010

Volatility is the Key

Investors have been hearing me say “hold steady” with positions for several weeks now as world credit and currency markets shift against weakening sovereign debt situations and increasingly conservative fiscal policies. Domestic economic issues impacted U.S. equity markets this week, leaving nearly all stocks to close down for the week. Small-cap indices are still “in the black” for the year suggesting that the U.S. market correction is still a matter of deleveraging among large funds that are primarily focused on large- and mid-cap stocks. Nonetheless, the report of weaker than expected job creation in the private sector is unnerving for everyone charged with financial decision making from portfolio calls to capital spending to employment levels to corporate or government debt issuance. That productivity in the U.S. remains at a record rate is no consolation as it is largely as a consequence of maintaining output levels with barebones staffing levels.

Several stocks in our Crystal Reports Coverage Universe have fallen well into the buy range of our trading guides. We note that price level is not the only factor and is perhaps a less vital factor than is volatility as a cue to extend long positions in U.S.-listed small cap. U.S. volatility measures such as the CBOE VIX increased significantly last week to levels well above averages even though they are still not any where near the peaks established during 2009. We view current volatility levels as at worst a signal of confusion in the market or at best evidence of material differences in investor sentiment. Is the jobs report a signal that economic recovery is stalling? Is May 2010 simply a month wherein the private sector caught its breathe after two stressful years of bad news?

We view current price levels in the small-cap sector as compelling on a stock-by-stock basis, but consider the volatility indices as a cue that investors expecting a quick rebound will likely be disappointed. Indeed, prices could go lower. Thus we suggest only investors with long-term investment horizons and the patience to hold underwater positions should be active buyers in the current U.S. equity market. Everyone else should be holding positions and waiting for the volatility clouds to clear.

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