Why I'm Not Worried About A Pullback In The Market

Among the many records set by the markets this year, one, in particular, stood out for me — the CBOE Volatility Index, also called the VIX. On July 28, while the decision-making arm of the U.S. Federal Reserve was meeting, this indicator of market volatility hit 9.04, a record low.

It’s not just a large-cap phenomenon. A variety of markets are calmer than normal. The VIX’s small-cap counterpart, called the CBOE Russell 2000 Volatility Index or RVX, is presenting the same picture. As you can see from the chart below, the RVX is also trading at record-low levels these days.

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Nobody likes chaos. But these record-beating readings of the VIX and the RVX have many investors scratching their heads. After all, with stocks trading at new highs and expensive valuations, shouldn’t the market express some kind of concern?

Where’s the anxiety? Where’s the fear?

And, even more important, what if the volatility returns? Would that necessarily spell doom and gloom for investors?

The answer, of course, is that it depends (more on that later). But regardless, as is often the case, investors will be best served if they don’t let an indicator get in the way of a well-designed strategy. This should ring especially true for long-term investors.

What A Pullback Would Mean For Us
Following one simple rule will help both income and growth investors stay the course. It also applies to investors hunting for long-term winners in smaller-cap stocks, as we do in my premium aggressive-growth newsletter, Game-Changing Stocks.

Keep in mind that what we call “game-changers” are a special breed. More often than not, these stocks are marching to the beat of their own drum. Investing in them requires a combination of confidence and flexibility. Investors should, together with a longer-term commitment, remain ready to accept that earlier projections may no longer be feasible.

Indeed, just as with any investment, it helps if you can get a new opportunity to buy at a better price.

So let me get back to the “it depends” answer…

I believe that, at this time, if market volatility picks up, it won’t necessarily signal a market correction.

That’s because volatility indicators, in effect, measure market swings — both up and down — for both the S&P 500 large-cap index (the VIX) and the Russell 2000 small-cap index (the RVX). These two indices cannot decisively indicate where the markets are going. Moreover, in most cases, because of the way the VIX and the RVX are calculated, they tell us more about today’s market then they tell us about tomorrow’s.

Still, they do offer clues about investor sentiment. For example, these days, investors as a group seem to do very little worrying. The record-low VIX, for instance, tells us that the large-cap S&P 500 index has been climbing to its recent records without much drama.

The same is true of the small-cap Russell 2000 — so far this year, its biggest decline has yet to exceed 5%. This is atypical for what is usually a quite volatile index… just look at the chart below.

In the past three and a half years alone, the Russell 2000’s rally was interrupted by four corrections (a drop of 10% or more from a recent peak) in 2014 and 2015; even in 2016, when the index began to recover in earnest, we’ve seen several sharp — albeit less than 10% — declines.

Second, even if there were a pullback, it wouldn’t be too bad a thing.

Investors sometimes tend to forget the simple fact that pullbacks are part and parcel to healthy markets. They let the markets recharge and create new buying opportunities. Investors who sell into a pullback usually come to regret it. And, at this time, I believe at least some volatility would be very helpful to the general health of the markets.

Moreover, unless market fundamentals change dramatically, a pick-up in volatility (which, it seems, at this time has nowhere to go but up) will be welcomed by the markets. Many money managers will take advantage of a more normal pattern of volatility to potentially sell some appreciated holdings and pick up some new ones, utilizing a more active approach and, in effect, helping the stock market discover new opportunities.

For my Game-Changing Stocks subscribers, this will likely mean more good game-changing ideas at better prices. If markets become more active, that could simply end up giving the stock market a long-needed refresher. Of course, the underlying reasons for a volatility pick-up would matter a great deal, but, at this time, I fully expect to use the likely increase in volatility to our long-term advantage.

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