Why Panic Sellers May Be Sorry

03/17/2011 7:00 am EST

Focus: MARKETS

Igor Greenwald

Chief Investment Strategist, MLP Profits

Panicky investors hit the sell button as a cascade of bad news washed over the market. Should you join the stampede?

The CBOE Options Volatility Index (VIX), also known as the Fear Gauge, soared 29% at the peak of panic today, from 24 (Somewhat Concerned) to 31 (Buying Potassium Iodide).

This is notable because there have only been seven other occasions, since this bull market began two years ago, that the VIX closed above 27 (filtering out spikes that occurred in close proximity to each other).

Instances VIX Has Risen Above 27
Date S&P Close That Day 15 Days Later % One Month Later % Two Months Later %
July 2, 2009 896 940 4.9% 1,003 11.9% 995 11.0%
August 17, 2009 980 998 1.8% 1,065 8.7% 1,088 11.0%
October 1, 2009 1,030 1,097 6.5% 1,043 1.3% 1,109 7.7%
January 22, 2010 1,092 1,057 -3.2% 1,108 1.5% 1,166 6.8%
May 6, 2010 1,128 1,088 -3.5% 1,065 -5.6% 1,028 -8.9%
June 22, 2010 1,095 1,070 -2.3% 1,094 -0.1% 1,072 -2.1%
August 24, 2010 1,052 1,099 4.5% 1,149 9.2% 1,183 12.5%

In those seven instances, the S&P 500 gained an average of 1.2% over the next 15 days, an average of 3.6% in a month, and an average of 5.4% after two months.

The average monthly gain during the current bull market has been about 2.2%. So, VIX readings like today’s have produced outsized gains—even relative to this record-breaking bull market—over a two-month and (especially) over a one-month period. 

Of course, it’s hard to blame anyone for selling stocks in bulk, when Western bankers—presumably the smart money closest to the nuclear disaster in Japan—are fleeing Tokyo in hastily chartered jets.

After stabilizing early in the day, the market took a major tumble on reports that Europe’s energy commissioner called the site of the critically damaged nuclear plant “effectively out of control.” 

And though he’d said the same thing a day earlier, in comments apparently based on nothing more than his own fears and media reports, the markets found Guenther Oettinger’s comments more salient than anything coming out of Japan, where authorities appeared to be well behind the curve in dealing with the situation.

Japan has ordered evacuations within a 12-mile radius of the plant, and urged people within 18 miles to stay indoors, while the United States has just advised its citizens within 50 miles to stay indoors or leave.

Japan has so far rated the nuclear accident at Fukushima less serious than Three-Mile Island on the global scale for such calamities— but private experts think it’s progressed well beyond that stage. An industry expert from the Massachusetts Institute of Technology memorably labeled Fukushima “a slow-moving nightmare.”

Meanwhile, on the other side of the world, the Saudi-inspired crackdown on the mostly Shiite protesters in Bahrain poured more grease on the kitchen fire, leading to a rebound in plunging oil prices. Light, sweet crude for April delivery closed up 1.08%, to $98.23 per barrel, after trading as low as $96.22.

As popular uprisings roil the Arab world, the erstwhile US-Saudi alliance appears strained to the breaking point, what with the US position on Bahrain now indistinguishable from Iran’s.

Beyond catastrophe and geopolitics, purely economic reasons to sell cropped up as well. “Inflation pressures bubbling, home building dives,” was the Reuters summary of the morning’s economic releases. The fact that housing starts are down amid a glut of unsold homes shocked no one.

And while producer prices popped 1.6%—more than double what economists had been expecting—the fact is that many of the commodities that fueled that increase, from oil to grains and metals, have since sharply corrected to the downside.

Still, setting aside stronger consumer spending, some tenuous and long-overdue hiring, and the strongest corporate balance sheets in decades, one could plausibly argue that the Federal Reserve’s bond purchases—while slated to continue through June—have already failed to assure a self-sustaining recovery.

Adding to the negative mood, securities analysts sharpened their pencils and stabbed two current market darlings. JMP Securities (say, who?) downgraded Apple (AAPL) to “market perform,” citing a slowdown among Taiwanese tech-contract manufacturers. Another brokerage, Bernstein, cooled its ardor toward IBM (IBM).

Caught in the downdraft were strong stocks like Oracle (ORCL), which fell 5% without any negative publicity whatsoever.

It all adds up to a valid reason to sell—except, of course, that it rarely pays to sell when bearish sentiment has such a stranglehold on traders.

On three of the seven prior occasions during the last two years when the VIX has spiked above 27 after at least a month below that level, the S&P 500 was at least 11% higher two months later. The other four times still average out to a gain.

So the odds that the market will be significantly higher by mid-May outweigh all the possible black-swan outcomes by enough to remain enthusiastically invested.

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