Volatility Index at Warning Level: Steps to Avoid a Body-Slam to Your Stocks

The U.S. stock market continues to climb an El Capitan wall of worry. Our sluggish economy, soft demand from our trading partners in Europe and China, and the impending cliffhanger of how Congress will deal with the looming fiscal cliff are no match for the McFerrin rally.

^INX Chart

^INX data by YCharts

Yet one of the most telling market barometers is pretty much screaming “look out below.” The VIX index, a measure of expected volatility over the next 30 days has all but flat-lined lately.

VIX Chart

VIX data by YCharts

And that’s not necessarily a good thing for stocks. There’s an inverse relationship between the VIX and the market. Here’s the “fear gauge” compared to the path of the SPDR S&P 500 ETF (SPY).

VIX Chart

VIX data by YCharts

This past August, Robert Farago, head of asset allocation at Schroders Private Banking told the Financial Times when the VIX index sinks below 15 it “is flashing red for us.”

We’re there right now; over the past 12 months the VIX has fallen by more than two-thirds.

VIX Chart

VIX data by YCharts

You could look at that and high-tail it out of stocks, but then you run the equal risk of missing the next leg up. A better approach is to comb through your portfolio and look for stocks whose longer-term fundamentals aren’t looking great and replace them with better valuations. You know the routine: would I buy this stock at today’s price? If you can’t answer in the affirmative, why do you still own it? (Yes, taxes can be a consideration, but don’t let that tail wag your portfolio dog.)

This is also the sort of market juncture where you want to have your go-to list ready. There’s no guarantee the markets will hit a speed bump in the near term—but if it does, that’s when the key Buffett rule should come into play: be greedy when others are fearful.

Ycharts editor Dee Gill recently unearthed growth stocks trading at sane valuations, including Berkshire Hathaway (BRK.B) holding DaVita (DVA).

Or for dividend yield seekers, large quality companies with big cash hordes, such as Microsoft (MSFT) and Johnson & Johnson (JNJ) are built to weather volatile markets better than growth stocks.

Carla Fried is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

Read more articles about: Investing Ideas  

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