Analysis: U.S. investors fear volatility but remain steadfast

Amateur trader Yan Qin checks her computer for stock reports in New York December 7, 2010.

NEW YORK (Reuters) - Investors are worried the U.S. stock market has rallied for six months without significant correction but they're not ready to call it quits.

The CBOE Volatility Index VIX, Wall Street's so-called "fear gauge", was on track to end the week about 5 percent higher even as the S&P 500 index rose to twice its value from just two years ago. The index is usually inversely correlated to the S&P and a rise in the VIX typically means a drop in the stock market.

"There is definitely high anxiety because everyday it looks like the market is at the top and it's going to have to correct," said James Dailey, portfolio manger of TEAM Asset Strategy Funds in Harrisburg, Pennsylvania.

"Are we due for a pullback? Yes. When? that's the big question. Money just keeps flowing into equities."

The VIX's overall level of 16.51 is still historically low but substantially higher than recent volatility. That suggests investors see more share gyrations in the weeks ahead.

According to Steve Place, founder of options analytics firm investingwithoptions.com, realized volatility on the SPDR S&P 500 exchange-traded fund has fallen back to levels of "support" last seen in April 2010 and Dec 2009.

The 20-day historical volatility level on the ETF, also known as "Spiders", is at 9.89, suggesting a calm market even as stocks stand at levels analysts consider overbought. During the mini-flash crash in May, the level shot up to 32.

"For me, to call a bottom in volatility would essentially be me calling a top in equities, which is not something I am willing to do at this point." said Place.

"Domestic equities are where the capital has been going into and we don't know when that will stop."

Money poured into risk assets like stocks in the last quarter of 2010 after the U.S. Federal Reserve pledged to keep interest rates low and pump another $600 million into the U.S. economy by purchasing more Treasury debt. Hopes the Fed's action would inject life into a sluggish U.S. recovery helped spark a 20 percent gain in the last six months.

BIGGER CORRECTION?

Supporting the optimism in the market, BofA Merrill Lynch Global Research recently raised its 2011 earnings-per-share estimates on the S&P 500. Both Credit Suisse and UBS AG boosted its year-end projection for the S&P. Credit Suisse is looking for 1,450, while UBS expects 1,425.

"When the market grinds higher and the longer that persists, the fall tends to be more abrupt and volatile," Dialey said.

"The 3-5 percent correction that the market had anticipated might now turn into a 5-10 percent one."

In signs that the momentum might be dwindling in the market, trading volume has been light recently, struggling to match the year's average of about 7.9 billion shares on the New York Stock Exchange, NYSE Amex and Nasdaq.

(Editing by Andrew Hay)