Investors Savor Period of Calm, Knowing It Can’t Last Forever

Times Staff Writer

You can’t ask for a better stock market than the one we’ve had for the last 12 months.

And that’s what gives some investors pause. This has been such a benevolent period, everybody knows it can’t last forever. The “then what?” question begins to loom larger -- particularly for people who believe they can’t afford to see their nest egg degraded, even temporarily, from these improved levels.

Not only has the surge in share prices since last spring been across the board, but the gains have come with very little volatility, on balance. In other words, easy has done it, a welcome respite for investors shell-shocked by the wild, and mostly downward, moves of 2000 through 2002.

The lack of volatility is something that most people probably can’t quantify, but can feel. There’s no great sense of imminent danger in the market. There’s a relative absence of nervousness. All in all, auto-pilot has been a fine investment strategy for the last year.


A few numbers show just how rewarding -- and free of bumps -- the ride has been:

* With the exception of September, the blue-chip Standard & Poor’s 500 index has risen every month of the last 12. It even advanced in February, adding 1.2%; historically, the second month of the year has been a loser for the market.

* Since the rally began on March 12, shortly before the Iraq war was launched, the S&P; index has soared 43%. And since April 1, it hasn’t pulled back even 5% before resuming its climb.

Many individual stocks have suffered bigger declines along the way, of course. But the lack of even a 5% “correction” in the broad market has helped to underpin confidence, while also frustrating investors who’ve been hoping for a sell-off so they could buy in at cheaper prices.

* The technology-dominated Nasdaq composite index, the very symbol of market volatility for much of the last decade, has rocketed 60% since mid-March. As with the rest of the market, however, Nasdaq’s rebound has been a deliberate affair: The index rose or fell more than 2% on just 39 days in 2003. So far this year that size move has occurred in three trading sessions.

By contrast, Nasdaq had 134 of those 2%-plus days in 2000 and 101 in 2002, according to James Stack, a veteran market analyst and editor of the InvesTech Research investment newsletter in Whitefish, Mont.

Some Wall Street bulls say the market’s sustained comeback ought to be viewed as the well-deserved reward for investors who suffered through the 2000-02 bear market, the worst in at least a generation.

The strength and pace of the rebound also could be a sign that, by last winter, the decline in stocks had become grossly overdone in the aftermath of the corporate scandal wave of 2002 and in the face of war fears.


But how much longer can the market be so free with the winnings, and so blissfully steady in handing them out?

Just about everyone on Wall Street believes that stock price gains will be harder to come by over the next year compared with the last one. No revelation there.

Few investment pros describe the market as cheap. The average blue chip stock is priced at 18 to 21 times this year’s estimated earnings per share, depending on whose estimate you believe. Those are lofty numbers, historically.

Yet the bullish bet is that stocks still can advance modestly over the next year, and perhaps into 2005, because investors will remain focused on the recovering economy -- and because short-term cash accounts and bonds are likely to remain poor competition for equities.


With the average money market mutual fund yielding 0.5%, that return could triple in the next year and it still would be minuscule.

Most bonds, meanwhile, are always a bad bet at a point in the economic cycle when there’s a better chance the Federal Reserve will be tightening credit than easing it.

The S&P; 500 index is up 3% so far this year. If it were to end the year with a total return of 6% or 7%, that still might beat the primary competition, though it wouldn’t compare with the heyday of the last bull market.

For many investors, the question of whether to put more money into stocks, or leave in what they already have there, may come down to market volatility: If things begin to get crazy again, and daily share price swings become exaggerated in either direction, the public could recoil in horror.


Periods of low volatility always give way to periods of high volatility. Nonetheless, just because we’ve had one year of low volatility doesn’t mean it has to end here, said John Bollinger, head of Bollinger Capital Management in Manhattan Beach and a long-time chronicler of market trends.

“Volatility has no cyclicality,” he said. “There is no pattern in the times between peaks and troughs.”

One measure of expected market volatility is the so-called VIX, short for volatility index. It tracks investors’ use of “put” and “call” option contracts on the blue-chip S&P; 100 stock index to gauge expectations of market moves. Options allow investors to make leveraged bets on rising stock prices or to buy some protection against a drop in prices.

A low VIX reading generally means investors have low fear levels and aren’t expecting a serious market decline ahead. A high reading indicates a high level of nervousness and expectations of greater swings in stock prices.


The VIX was at 14.55 on Friday, near the multiyear low of 14.34 reached on Jan. 21. By contrast, the VIX was more than three times as high at its 2002 peak level.

The decline in the VIX “tells you that the fear level in the market has really dropped,” Bollinger said.

He thinks that’s for good reasons. For one, the Federal Reserve has gone out of its way to assure investors that the central bank isn’t feeling pressure to raise interest rates anytime soon, Bollinger said.

Second, he said, investor sentiment has been buoyed by the crackdown on corporate fraud in the post-Enron Corp. environment. The suspicion that everything’s rigged has been lessened, at least somewhat.


Third, and perhaps most important, corporate earnings have rebounded dramatically over the last two years, Bollinger noted. In the long run, earnings drive stock prices.

The VIX mostly held at low levels, similar to current readings, in the early- and mid-1990s. That was a period of slowly rising stock prices that gave way to faster-rising prices, and higher volatility, in the late 1990s.

InvesTech’s Stack says there’s no reason to believe that market volatility must rise soon. He argues that it might even decline further.

A sustained period of low volatility is “exactly what investors should expect when comparing to the aftermath of prior tumultuous bear markets,” Stack said.


But even if the volatility level of the market as a whole remains subdued, there could be a lot going on under the surface, Bollinger and Stack say.

In fact, some investors’ stock preferences have been changing over the last month. Many technology shares have pulled back. The Nasdaq index fell 1.8% in February. By contrast, some sectors that were weaker performers in 2003, such as energy stocks, have been attracting buyers.

The market’s shifts may reflect that investors are beginning to ask questions that they were able to put off for much of last year, as nearly every stock rose.

For example, which stocks might be hurt worst if the Fed begins to tighten credit, even modestly, later this year?


How would the market be affected if oil prices, which are holding above $35 a barrel, fail to come down meaningfully this year?

What if the dollar continues to fall? Which companies and industry sectors might benefit most from a dollar-induced export boost?

Perhaps most important, Bollinger said, is the question of earnings growth, and which companies may find it toughest to sustain strong profit gains in the second half of this year.

“That’s where high investor expectations may crash into reality,” he said.


With volatility low, and most stocks holding onto their gains of the last year, investors ought to use this period as a gift, Stack said: It’s a good time to think about how your portfolio might be restructured to be better prepared for the risks and opportunities that may lie ahead.

At the very least, investors ought to consider whether they could do a better job of diversifying their stock mix. Lack of diversification among big and small stocks, U.S. and foreign, and industry sectors was the downfall of many people in the last bear market.

Should the market turn more volatile, that’s beyond your control. But you can manage the volatility in your own portfolio by being properly diversified and hedged for possible turns in the economy, interest rates, inflation, etc.

“The important thing about hedging risk is not trying to find those market sectors that will spectacularly outperform others, but rather to reduce your overall volatility,” Stack said.


That will take more work than an auto-pilot investment strategy, but in the long run it should be far more rewarding.


Tom Petruno can be reached at For recent columns on the Web go to