Don't panic, buy volatility

One thing we can all agree on: shares have been volatile lately. So now what?

Stay cool - and buy volatility. Volatility is normal. Even steep volatility happens often within bull markets. But on 8 August 2011, something very unusual did happen - every single S&P 500 stock was down. That's very bullish.

Surprised? Recent volatility looks like a classic bull market correction - a short, sharp shock driven by a huge story - not a bear market. In a correction, stocks fall fast, but typically rebound just as fast later, moving even higher. I don't know anyone who's ever made a career of consistently market timing corrections - it's simply too treacherous.

As far back as I can measure (1982), all S&P 500 shares have fallen in one day just once before - 27 October 1997. One month later, stocks were up 8.4%, three months later they rose 12%, and six months later they boomed 27.9%. All S&P 500 shares falling at once is beyond rare (and bullish). But there have been 13 times when over 99% of US shares have fallen in one day. One month later, all but three times shares were positive, averaging 3.9%. Three months later, stocks averaged 7%. Six months later - just twice shares weren't positive, averaging 16.7%.

Those two times were both in 2008 - 29 September and 15 October - 99.8% and 99.4% of S&P 500 shares fell. Six months after 29 September, shares were down 22.8%. Amazingly, six months after 15 October - a little over two weeks later - shares were down just 4.1%. Take on just a week more, and shares are positive. That's how fast shares move - and it's true in the US, UK and globally.

The question is: Is now more like September 2008 or the far greater times huge volatility was followed by a big rebound? My guess is the latter. This is no 2008. You will probably never see another 2008 in your lifetime. And while everyone always wants us to, we never, ever fight the last war next.

Yes, the eurozone faces big issues, but those issues are well known and now long in pricing. At this point, the euro's existence is assured at least through 2013 - what we're getting now is politicians hemming and hawing to curry favour at home. No one has any incentive to let the eurozone implode in fiery fashion.

Plus, across the board, long-term interest rates are falling - everywhere! Some of that is the European Central Bank buying (or planning to buy) eurozone debt, but if markets believed default risk were higher now, would PIIGS rates be uniformly lower now than a few weeks ago? Would Portugal's two-year rates have fallen 9% and Ireland's 13%? Would corporate rates be uniformly lower? No...

The global economy is growing and is at all-time highs. The US economy accelerated from the first quarter to the second quarter. Nominal US and global GDP is at all-time highs. Globally, retail sales are strong and US retail sales have accelerated; in April, May, June and July, retail sales grew 7.9%, 8.3%, and 8.5% respectively year-on-year. US corporate revenues will grow 12% in the second quarter and it's the same globally. This doesn't paint the dire economic picture many believe.

I continue to believe 2011 delivers relatively muted broad index returns, with a lot of choppiness en route, and recent volatility is perfectly in line with that. You can expect more. But I don't see it presaging disaster. Rather, it's just The Great Humiliator (the proper name for the stockmarket) trying to fool you out of stocks before the bull market resumes with gusto in 2012. Get ready now with shares like these...

Garmin, based in Kansas, is a leader in global positioning systems. Consensus views are dour, since automotive uses, the largest GPS market, are being served with smartphones. But operating profits from more proprietary, sophisticated devices for outdoor and fitness applications (hunting, hiking, cycling, etc.) have already eclipsed those from autos.

Garmin's marine and aviation devices should resume growth as the economy improves. The stock sells at 12 times my 2011 earnings estimate and has a 4.9% dividend yield.

Most investors are avoiding pharmaceutical stocks because they are convinced profits will vanish after a firm's drug patents run out. I don't buy it and think stocks like Gilead Sciences, at 11 times 2011 earnings, is a bargain.

Gilead has treatments for things like HIV and basic influenza. It is also in the cardiovascular and respiratory- therapy market. Gilead's 14 proprietary drugs are blockbusters. Tamiflu alone is a huge hedge against a global pandemic. I believe we will see growth and P/E expansion before this economic cycle ends.

Similarly, Geneva-based STMicroelectronics is far from the sexiest of the world's semiconductor firms, but it is Europe's largest. Northern European business is expanding rapidly. With their sales and profits at all-time highs and the company selling at 80% of this year's sales and eight times its earnings, it earns a place in my portfolio despite its lack of sex appeal. It could easily sell at 12 times higher earnings.

Get more on the opportunities the recent rollercoaster nature of indices brings, inTraders lament lack of summer lullandAlternative hedges against market volatility.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.