Tuesday, August 09, 2011

Shake Rattle n Roll

The trading week is well on its way to the history books…and its only Tuesday…bringing back a bit of nostalgia for the old days.  There appears to be a “whole lot of shakin’ goin’ on” but it is not the trim beats of old time jazz tunes. It is the heady to and fro of market volatility that has investors harkening back to the fall of 2008.

Indeed, the U.S. equity market has not experienced the current level of volatility since those memorable days in late 2008, when the financial world seemed to be coming apart at the seams.  The CBOE Market Volatility Index, the popular VIX measure, appears poised to hit 50 before the week is over.

What does new volatility mean for stock selection?  In my view, it is a clear call to search far and wide for the deepest value possible. 

The spike in volatility is a clear sign of uncertainty and confusion.  Much has been written by much smarter financiers and economists than me about market efficiency.  Many argue that information is immediately incorporated in stock price.  I beg to differ.  The information may be in the marketplace but investors are wont to accept news that differs from their previous viewpoint.  They are even more reluctant to take losses in a stock and will close their eyes to the most blatant of truths until forced to accept the obvious.  Then comes the famous “capitulation” and only then does all information become reflected in the stock price.

Even then there can be a whipsaw effect as we have seen in the past few days  -  one deep correcting day following by a small but still significant upturn in the major indices.  Clearly not everyone got the memo and even some who got it may have misunderstood the bad news of economic slowing and fiscal disaster.

Deep value stocks provide a cushion against such volatility. They are less likely to participate in wild price movements as the stock is already priced at low multiples to earnings or cash flows.  As might be expected I would recommend a screen for strong cash flow, low debt, and high sustainable growth rate all at low price to earnings or price to cash flows multiples.  Sometime left out of popular screens is beta.  Low beta names are a good play in a volatile market, giving investors much lower return and many more nights of restful sleep knowing their picks are not likely to vary much more than the broad market.

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