Impending Correction?

[Fish2006]

... it seems as though people are afraid of a crash. Don't believe the hype.

There is this thing called the VIX. The Volatility Index. It represents how much volatility there is in the market in general. When the VIX goes higher, you expect bigger swings. Some call it a "fear and greed" indicator (when its high) and a complacency indicator (when its low).

In the past year, the VIX has been at historical lows (hovering around 10). On Tuesday, it jumped to around 17, higher than its been for a long time (multiple years). What does this mean? Some people thing it means there is a correction coming, and they are probably right.

But it also means we are "reverting to mean", meaning, the normal place for the VIX has typically been in the mid-teens. In the 90s, with a DOW at half the value or less than it is today, it was not uncommon to see 100 point moves a couple times per month. Lately, at 12k+, until this week, 100 point moves (either way) have not been that common.

Bottom line, you should not be suprised to see the market go 250 or more either direction in a day. No reason to panic. Investing is about fundamentals. Trading is about psychology. If I were trading this market (i.e. day or swing trading) - I would be shorting almost everything, because we are probably going to drop about 5% short term. However, if you are an investor (in for longer than a few days) - this drop is like the goods going on sale.

The fundamentals are that we have a market PE ratio right now of about 14. If we drop another 5%, we get to 13. Every time you hear about corporate profits going up 10%, and the stock market does not make a comparable move (or goes down), that drives the market PE lower.

The reason for all the M&A activity (buyouts, mergers, aquisitions) - such as the recent Texas Utilities deal, is that stocks are considered CHEAP by the big money guys (primarily private equity). You don't see offers to buy companies at the vigor we are seeing them today when stocks are considered expensive.

If stocks get cheaper, look for:

Companies buying back their own stock (because thats when you do when you think your stock is cheap)
Increasing dividends - especially dividend yields (if the dividend stays the same, but the stock price goes down, basic math says the yield on the dividend has to increase... once yields go from 4% to 6%, you have a better return on dividends than bonds)
Foreign buyouts (China, despite the recent problem in their stock market - has tons of cash and WILL buy companies once they are attractive enough - and have been doing so).

All these things make being an owner of stock attractive. Do not be afraid of this market. That said, investors should average in - dont buy everything all at once - if you are buying 100 shares, buy them in 4 lots of 25 over the course of a few weeks.