Harry Rady News

05/03/2011
Investor’s Business Daily
Ho, Trang

Mutual fund investors enjoyed handsome returns in April as a wave of stellar corporate earnings reports powered the market to new highs despite a torrent of bad news.

Weighing on the market were war in the Middle East, Japan’s nuclear crisis, a free-falling dollar, rising oil prices, the Fed ending its stimulus program and U.S. GDP rising at 1.8% annualized — less than expected.

Bond funds were also broadly higher, helped by stable interest rates, steady if slow U.S. economic improvement and flights to safety in U.S. assets.

Not every May is bad, but any further advance this month would go against the norm. The month marks the beginning of the Dow and S&P 500′s historically “worst six months” of the year, according to Yale and Jeffrey Hirsch of the Stock Trader’s Almanac.

“The list of potential risks does continue to grow, including high energy prices, changing inflationary expectations and U.S. fiscal problems,” Bob Doll, chief equity strategist at BlackRock, wrote in a client note.

“And stocks have come quite far quite fast, suggesting that some sort of near-term consolidation may be coming,” he added.

Small caps, which climbed to a record high, helped push the average stock mutual fund up 2.63% in April and 8.94% year to date.

Small-cap growth and midcap growth funds, both rose 3.90%. Large-cap growth funds, +2.82%, climbed to their highest level in nearly three years. But large caps failed to take leadership as many analysts had expected on cheap valuations.

More Room To Roam

Small and midcaps are expected to continue outpacing large caps because of their ability to grow earnings at a faster clip. They also make for appealing takeover targets at a time when corporate America has lots of cash on the balance sheet and with interest rates likely to remain low for the foreseeable future.

“I think we’re at the beginning of the largest M&A (merger and acquisition) boom that we’ve ever seen,” said fund manager Harry Rady. Rady Contrarian Long/Short has risen 7% year to date and 5% in the trailing 12 months. Rady Opportunistic Value has climbed 8% and 11.6% in those periods.

U.S. companies have “more than a trillion dollars on their balance sheets and so they have to make acquisitions to justify the multiples they’re trading at,” he said.

They’re also having difficulties growing their sales, and profits will have to resort to growing by buying out smaller companies. More than 10 of his portfolio holdings have been acquired in the past year.

Rady buys companies he believes are potential takeover targets and trading far below their intrinsic value. They include BlackBerry maker Research In Motion (RIMM) and cloud-computing giant F5 Networks (FFIV).

“The small and midcaps seem more stretched in valuations, but they can grow earnings at a faster rate too,” said Brian Lazorishak. He co-manages Chase Mid Cap Growth and is a senior quantitative analyst at Chase Investment Counsel, which oversees $1.4 billion in assets. “But at the same time, we can find plenty of stocks that have attractive valuations too.”

Lazorishak has overweighted his portfolio in technology stocks, which account for more than 30% of assets, including CommVault Systems (CVLT), Fiserv (FISV), Informatica (INFA), Teradata (TDC), Tibco Software (TIBX) and VeriFone Systems (PAY).

“They’re all benefiting from improved technology spending both here and overseas,” said Lazorishak. “They continue to have strong earnings momentum and strong earnings growth quarter after quarter.”

As a bottom-up stock picker and as a growth-at-a-reasonable-price (GARP) investor, he pays little attention to macro economic trends. He screens for companies that have at least 10% historical earnings growth annualized for five years and then assesses potential earnings and sales growth drivers, risks, valuation and technical trends. His fund has returned 18% year to date and 36% in the trailing year.

Global health care funds outpaced all sector funds, rising 6.79% in April, pushing their year-to-date return to 14.77%. Another defensive sector, consumer goods funds, rose 5.39% for the month and 7.71% so far this year.

“The knee-jerk reaction when the market goes down is people shift funds into those defensive areas,” said Lazorishak, referring to the market’s brief pullback during the second and third week of April. “Consumer staples have been a laggard, so there’s reversion to the mean there.”

Real estate funds climbed 5.32% in April and 11.93% year to date. Global real estate tagged along with 5.12% and 7.83%.

Lagging all other sectors last month were natural resources funds, up 0.36% and financial funds, up 0.71%.

Batting For The Cycle

Cyclical sectors with large overseas operations capitalizing on stronger emerging market demand, dollar weakness and high commodity prices are expected to post the best year-over-year gains, says Alec Young, equity strategist at Standard & Poor’s.

He recommends that investors overweight energy, industrials, basic materials, while underweighting consumer discretionary and utilities — the sectors dependent on domestic consumption.

With two-thirds of the S&P 500 companies having reported first-quarter results, nearly three in four (72%) have beaten consensus earnings estimates, with 70.9% exceeding top-line forecasts.

International funds eked out a gain despite the lingering economic shock from Japan’s earthquake, war in the Middle East and Europe’s credit crisis.

The average world stock fund gained 4.79% in April, outpacing U.S. stock funds. Europe was the best of the world regions, rising 7.43%. Pacific ex Japan funds followed with 4.84%. Emerging markets funds climbed 3.42%.

China funds gained 3.24%, while Latin America trailed with 2.01%. It’s still the 10-year leader, with an average annual return of 20.06%.

The worst-performing group in April, Japan funds, were still positive with a 1.99% gain.

Original Article - http://www.investors.com/NewsAndAnalysis/Article/570921/201105031801/Small-Caps-Lead-Mutual-Funds-To-Best-Month-Of-11.htm

04/12/2011
CNNMoney.com
La Monica, Paul

About this time a year ago, few people on Wall Street knew who Fabrice Tourre was. That was all about to change very quickly.

April 16, 2010: Goldman Sachs (GS, Fortune 500) is accused by the Securities and Exchange Commission of defrauding investors in a complex pool of mortgage securities known as Abacus. At the center of the charges was a trader who described himself as the “fabulous” Fab.

Tourre and others at Goldman were later dragged in front of Congress to explain themselves. How could we forget the marathon hearing that tested TV censors everywhere thanks to the repeated reading of an e-mail with a naughty, scatological reference by Sen. Carl Levin.

Flash forward to today. Goldman has recovered from the worst of this scandal, but it’s still wounded. The stock, which tumbled last spring and early summer before settling with the SEC for $550 million in July, is up 25% from its lows.

But shares are still about 12% below where they traded before the SEC allegations came to light. Other big banks are still lower than this time last year. However, the broader market has enjoyed a nice rally. The S&P 500 is up nearly 10%.

So where does Goldman go from here? The company arguably stands to benefit even more from the recent uptick in merger activity, initial public offerings and corporate debt sales than just about any other firm on Wall Street.

Is that already reflected in the stock price though? Goldman Sachs currently trades at 12 times 2011 earnings estimates. That may sound inexpensive. But rivals Morgan Stanley (MS, Fortune 500), JPMorgan Chase (JPM, Fortune 500), Bank of America (BAC, Fortune 500) and Citigroup (C, Fortune 500) are all trading closer to 10 times this year’s profit forecasts.

Goldman also trades at a premium to its competitors on a price-to-book value ratio basis as well. Book value, which measures how much a company is worth after you subtract its liabilities from its assets, is a common yardstick to compare financial stocks.

Goldman’s price-to-book ratio is about 1.3. JPMorgan is trading around 1.1 times book while Morgan Stanley, BofA and Citi are each trading below book value.

‘Big ugly’ banks left out of market rally

Of course, Goldman has always enjoyed a premium valuation to its peers because of its reputation and leadership role among the blue blood investment banks. But does Goldman still deserve it?

Goldman may have settled with the SEC, but it looks as though investors still don’t completely trust the company. And Goldman continues to make headlines for all the wrong reasons.

Just today for example, there are some wondering if a negative call on commodity prices from Goldman — which up until now had been among the bigger commodity bulls on Wall Street — is turning out to be a self-fulfilling (and self-serving) prophecy.

Crude oil prices plummeted Tuesday, along with the price of gold, silver, corn, wheat and many other hot commodities.

There was also news Tuesday of a lawsuit filed against Goldman by the co-founders of chip company Marvell Technology (MRVL). Executives from Marvell claim that they were forced to sell shares of their company in 2008 due to what they allege was a fraudulent margin call.

It is obviously up to the legal system to decide who is right in this dispute. But the mere fact that Goldman is still being accused of shady practices just shows how risky it is to make bets on big Wall Street firms that, fairly or not, are often presumed guilty by the market.

“Goldman Sachs is likely dead money,” said Harry Rady, president and CEO of Rady Asset Management in San Diego. “The bad press isn’t reflective of the underlying fundamentals at the company. But the headlines are weighing on the stock.”

Bulls face first-quarter profit test

Rady said he sold his firm’s stake in Goldman for those reasons a few months ago. He also dumped Morgan Stanley, arguing that increased capital requirements will create a drag on both firms.

Bob Bacarella, manager of the Monetta Fund (MONTX) in Wheaton, Ill, said he also sold his stake in Goldman. He did so at the end of last year. I actually spoke to Bacarella shortly after the Abacus scandal last April, and at that time he was still bullish on Goldman. So what’s changed?

He said it’s now clear that the fraud charges against Goldman and concerns about how tougher financial regulation (much of which was crafted in the wake of Abacus) will impact the firm, will be an overhang on the stock for a while.

“I still like Goldman Sachs for the long-term,” he said. “But it’s out of favor. It’s not something I’d chase right now.”

Original Article – http://money.cnn.com/2011/04/12/news/companies/thebuzz/index.htm?source=yahoo_quote

04/15/2011
TheStreet.com
Holmes, Robert

Bank of America’s(BAC) first-quarter earnings results fell short of analysts’ estimates due to mortgage woes. Investment managers aren’t giving up on the U.S. bank stock yet.

Concerns over repurchases of soured mortgages, known as putbacks, have dogged Bank of America shares. While the S&P 500 has climbed more than 4% this year, Bank of America shares have underperformed, falling 1.6%. Today, the stock dropped more than 1% to $13.13. Bank of America reported a quarterly profit of 17 cents a share, falling well short of Wall Street’s average target of 27 cents a share.

Fund managers such as Harry Rady say Bank of America is only treading water, held back by the continued uncertainty around the bank’s credit portfolio and mortgage putbacks. Rady, who owns Bank of America in the Rady Opportunistic Value(ROVYX) along with several other funds, says investors should look past the quarterly numbers and understand Bank of America’s real value as a long-term holding.

“The risk/reward profile of Bank of America is attractive,” Rady said by phone Thursday from his San Diego office. “I would look at it as a compressed spring. If they can get this mortgage putback issue behind them, that spring could rocket this stock into the high $20s. Until that happens, I would suggest that it trades between $10 and $20.”

During the first quarter, the mortgage pains were significant for the bank. Bank of America was forced to set aside $1 billion to cover possible requests to repurchase mortgage securities. That’s nearly double the $526 million in the same quarter a year earlier, showing that the cloud of putbacks may continue to hang over Bank of America’s shares.

However, most investors should be well aware of Bank of America’s putback risk. Instead, Rady argues that investors would be wise to buy an institution for Bank of America at tangible book value, which is the estimate of the bank at liquidation values, because of how attractive the franchise name is once the bank can put its issues behind it.

“Any time you get an opportunity to buy a franchise — something with the name ‘Bank of America’ — for tangible book value, that’s like buying a business for the cost of the tables and chairs,” he says. “The downside is protected by the fact that we’re buying it at tangible book value. The upside is that when they fix the credit problems, the putback issues and the economy recovers, they’ll be rewarded for this valuable, irreplaceable franchise that exists.”

Robert Pavlik, chief market strategist at Banyan Partners, is also a fan of Bank of America over the long term. Pavlik says he personally owns shares of Bank of America, understanding that it will take time for the bank to clean up the mortgage foreclosure situation.

“I could probably make better money now if I traded it,” Pavlik acknowledges, “but this is an investment to put away in an IRA account and not look at it every day. Five years down the road, you’ll see these stocks trading higher and you’ll be happy with the return. If we didn’t have this issue surrounding the way they process foreclosures, people would be all over this stock.”

One reason Pavlik finds Bank of America attractive over a longer horizon is the expectations of rising interest rates. “The spreads that these companies are going to be able to capture by lending out money at a higher rate and borrowing at a lower rate,” he says. “That’s the place you want to be.”

Rady agrees, explaining that if interest rates rise, the yield curve would remain steep and allow banks to continue to capitalize on the spread between lending and borrowing.

“For banks, it’s just a spread game,” he says. “It doesn’t really matter what the actual numbers are as long as the spreads exist. In a rising rate environment, the yield curve is anticipating rates continuing to rise, and that means a steep yield curve. As long as the yield curve steep, it doesn’t matter how much rates rise. It certainly matters to the economy, but the bigger issues are credit and the mortgage putback issue.”

Other money managers are even more bullish on Bank of America’s prospects. Cliff Hoover, manager of the Dreman High Opportunity Fund(DRLRX), which owns a stake in Bank of America, says the stock is one of the most undervalued financials he has in the portfolio.

“Bank of America’s retail and small-business footprint is second to none,” Hoover says. “You’re starting to see some commercial lending growth in the U.S. There are improved credit metrics. Capital is strong within Bank of America and they’re building excess capital.”

Hoover says that individual investors are waiting for a “magic catalyst” before they step in to buy Bank of America shares. He says investors would be better off looking at normalized earnings for the bank the way professional investors would. Hoover points out that banks generated massive return on equity (ROE) by using leverage leading up the financial crisis. Given the corrective period bank stocks endured, investors now need to normalize earnings, he says.

“To rationalize these banks going forward, we valued banks back to their traditional ROE levels, realizing that the leverage will go down,” Hoover says. “The bedrock of our thesis is that Bank of America can easily generate a normalized earnings per share of about $3. With a price-to-earnings multiple of 10 on that, you get a $30 stock. That’s not a really aggressive number.”

In the wake of JPMorgan Chase’s(JPM) lower first-quarter revenue and with questions of how Citigroup(C) will fare when it reports quarterly results on Monday, money managers say Bank of America might be worth looking at today as the stock moves on the report.

“At tangible book value, where it’s trading right now, would it be logical to buy half a position at tangible book and if it gets cheaper they fill it out? Yeah, that’s a logical strategy,” Rady says. “It wouldn’t be crazy to buy a full position. At these prices, any strategy is reasonable.”

Original Article - http://www.thestreet.com/story/11083809/1/bank-of-america-still-a-fund-manager-favorite.html?cm_ven=tscmarketwatch&puc=tscmarketwatch

04/19/2011
Bloomberg BusinessWeek
Lachapelle, Tara

Johnson & Johnson, reeling from more than 50 drug and device recalls since the start of 2010, is trying to recapture its younger self by digesting Synthes Inc.

Synthes, the largest maker of devices to treat bone fractures and trauma, has an operating margin of 35 percent, the highest among medical-products makers including J&J with market values of more than $5 billion, according to data compiled by Bloomberg. Synthes has increased the amount of net income generated per dollar of revenue for seven straight years to the best in the industry, while J&J’s profit margin declined in two of the past four years, the data show.

J&J, with almost $28 billion in cash at its disposal, is in talks to acquire Synthes, a $19.4-billion company with only $98 million in debt, as it seeks to revive its image after product recalls and lawsuits over failed artificial hips. The world’s second-biggest maker of health-care products would gain a device company with almost 50 percent of the trauma market. Synthes’s operating margins are 45 percent higher than Smith & Nephew Plc, which investors had speculated was a target for J&J.

“J&J had a severe challenge to its premier reputation given all the recalls,” said Michael Holland, who oversees more than $4 billion, including J&J shares, as chairman of Holland & Co. in New York. “This relatively bold step to buy a premier company is a significant move to regain their luster.”

Share Gains

J&J’s shares rose as much as 1 percent yesterday before closing down 0.2 percent at $60.46 on the New York Stock Exchange. That was still the third-best performance in the Dow Jones Industrial Average, which slid 1.1 percent as Standard & Poor’s cut its outlook on U.S. long-term debt to “negative.”

Synthes advanced 5.6 percent to 146.5 Swiss francs in Zurich yesterday to give it a market value of 17.4 billion Swiss francs ($19.4 billion). The West Chester, Pennsylvania-based company said in a statement that it’s in talks with J&J about a possible combination. Synthes doesn’t intend to provide more information until a definitive agreement is reached or talks are terminated, it said.

William Price, a spokesman for New Brunswick, New Jersey- based J&J, declined to comment in an e-mail.

Shares of J&J climbed 2.2 percent to $61.80 in pre-market trading at 8:26 a.m. New York time today after the company reported first-quarter earnings that beat the average estimate from analysts and raised its full-year forecast. Synthes gained 1.9 percent to 149.3 francs.

‘Change the Focus’

J&J is considering an acquisition of Synthes after product recalls cost the company $900 million in sales last year. J&J removed almost 200 million packages of Tylenol, Motrin and other over-the-counter medications tainted by nauseating odors or improper ingredients. Its DePuy unit has also withdrawn 93,000 hip implants that failed at higher-than-expected rates, forcing repeat surgeries.

After the company’s McNeil Consumer Healthcare unit was charged on March 10 with violating U.S. law, the Food & Drug Administration expanded oversight of three manufacturing plants for at least five years. The settlement doesn’t preclude future criminal charges, the agency said at the time.

“They want to change the focus of the conversation,” said Erik Gordon, a University of Michigan business professor in Ann Arbor who studies the biomedical industry. J&J is “probably thinking, ‘Let’s have the conversation be the potential upside of something,’” he said.

While Synthes and J&J may “fit together,” J&J should be focused on fixing its in-house recall problems, he said.

‘Great Margins’

Synthes had an operating margin of 35 percent in 2010, the best among 17 medical-product companies with market values greater than $5 billion, including J&J at 27 percent, data compiled by Bloomberg show. The company’s efficiency turning revenue into operating income also topped rivals specializing in medical instruments such as Minneapolis-based Medtronic Inc., St. Jude Medical Inc. in St. Paul, Minnesota, and Boston Scientific Corp. in Natick, Massachusetts.

Synthes improved its profit margin to 24.6 percent last year from 6.1 percent in 2003, the data show.

“They have great margins,” said Michael Liss, a Kansas City, Missouri-based portfolio manager at American Century Investments, which oversees $109 billion and owned about 7.8 million shares of J&J as of Dec. 31. “It only helps J&J’s margins overall.”

Synthes has attractive margins because it’s in the orthopedics market and has implemented efficiencies, Gilgian Eisner, a spokesman for the company in Solothurn, Switzerland, said yesterday.

Artificial Hips

J&J had looked at buying Smith & Nephew, Europe’s biggest marker of artificial hips and knees, a person familiar with the plan who declined to be identified because the discussions were private said in January. The U.K. device maker had a 16 percent profit margin in the 2010 calendar year. The London-based company declined 3 percent yesterday, the most since January, after Synthes confirmed it was in talks with J&J.

An acquisition of Synthes would push J&J’s share of the $5.5 billion orthopedic trauma market to 54 percent from about 5 percent, and boost earnings between 4 percent and 5 percent in each of the next three years, Larry Biegelsen, a Wells Fargo & Co. analyst in New York, said in a note to clients yesterday.

The trauma market will grow faster than replacement hips and knees, according to Biegelsen.

J&J’s share of the $9 billion spinal-care market would almost double, he said. The company may have to divest some of Synthes’s spine business, according to Lisa Bedell Clive, a London-based analyst with Sanford C. Bernstein & Co.

‘Called Into Question’

Prices for Synthes’s trauma devices may succumb to the pressure that has narrowed margins for other medical devices, according to Michael Weinstein, a JPMorgan Chase & Co. analyst in New York.

The sustainability of Synthes’s profits “has been and should be called into question,” he wrote in a note yesterday.

Synthes’s exclusive arrangement with the Swiss AO Foundation may draw antitrust scrutiny from U.S. regulators, Bernstein’s Clive said. The non-profit teaches courses for surgeons using only Synthes products, leading to many becoming Synthes customers, she said.

Like J&J, Synthes has also grappled with product recalls. After reports that its Synex II Central Body components had failed in six people, leading to pain and loss of height for some, Synthes recalled the spinal implants in 2009.

Credit Ratings

The company was also ordered to sell its Norian unit, which pleaded guilty in November to one felony and 110 misdemeanor counts for conducting an unauthorized trial of its bone-mending cement products. Three patients died, according to the U.S. Justice Department.

J&J built up $19.4 billion in cash and near cash items and $8.3 billion in short-term investments as of the end of last year that could be tapped for acquisitions, compared with $16.8 billion in total debt, according to data compiled by Bloomberg.

The maker of health-care products is one of only four U.S. companies to have the top credit rating from both Standard & Poor’s and Moody’s Investors Service. Irving, Texas-based Exxon Mobil Corp.; Microsoft Corp. of Redmond, Washington; and Automatic Data Processing Inc. in Roseland, New Jersey, are the others, data compiled by Bloomberg show.

J&J is also ranked AAA in Bloomberg’s Company Credit Ratings, which analyze borrowers based on indebtedness, profitability and other financial ratios. Even if J&J added long-term debt equal to the current market value of Synthes, it would still have a rating of A2L, the fourth-highest investment grade level. J&J’s combined cash and short-term investments outstrip the market capitalization of Synthes by about $8.2 billion, the data show.

Biggest Deal

Synthes, which is not rated by S&P or Moody’s, had total debt of $98.4 million at the end of last year, compared with $736.6 million in cash and near-cash items and $1.25 billion in short-term investments, data compiled by Bloomberg show.

An acquisition of Synthes for about $20 billion would be the biggest deal in J&J’s 125-year history, surpassing the $16.6 billion purchase of New York-based Pfizer Inc.’s consumer health care business in 2006. Pfizer is the world’s largest maker of medical products by sales.

“J&J is what it is. It’s a big powerhouse,” said Harry Rady, who oversees $270 million as chief executive officer of Rady Asset Management LLC, a hedge fund in La Jolla, California. “They could choose to allocate resources to fight all these small battles, or they could make a transformational acquisition like this to really change the face of the company.”

Overall, there have been 7,336 deals announced globally this year, totaling $713.1 billion, a 29 percent increase from the $553.3 billion in the same period in 2010, according to data compiled by Bloomberg.

Original Article - http://www.bloomberg.com/news/2011-04-19/j-j-synthes-merger-obscures-product-recalls-in-instant-makeover-real-m-a.html?cmpid=yhoo

04/19/2011
Reuters
Moon, Angela

Options investors are betting on a sharp surge in beaten-down Cree shares following the LED maker’s earnings report after the bell.

Cree Inc (CREE.O) shares have lost nearly 38 percent on the year as investor enthusiasm waned. But better-than-expected numbers could turn the tide in the stock, and that could force the large contingent of short-sellers to cover their bets, boosting shares further.

“The market is telling us that there is a lot of short-term uncertainties in the stock,” said Harry Rady, CEO and senior portfolio manager of Rady Asset Management in San Diego, California, who owns shares.

“If they (the earnings) disappoint, it’s probably discounted in the stock price now. If it’s even a little bit better than expected, prices could go up even 10 to 20 percent.”

The stock was last trading at $40.89 a share. June call options have been active at the $45 strike price, a bullish bet on the shares.

Recent earnings revisions have been negative on the stock, especially after the bellwether LED maker cut its third-quarter revenue and margin forecast in late March due to higher customer investors and pricing pressure, signaling another disappointing quarter. For details, see [ID:nL3E7EN2BO]

According to Thomson Reuters StarMine, earnings estimates have been revised lower by 29.6 percent over the past 30 days, and revenue estimates are down 14.7 percent over the same period of time. The stock also scores very poorly in terms of price momentum as it has poor long- and medium-term momentum.

But the steady bets against the stock make it vulnerable to a short squeeze. More than 20 percent of the shares are being shorted and institutional ownership is high, at more than 92 percent, according to StarMine, and should earnings surprise, Cree could rebound sharply.

“It looks like one or more investors are speculating on a rally in shares in Cree. Bull call spreads in the June contract comprise nearly all of the options volume generated on Cree in the first hour of the session,” said Caitlin Duffy, options analyst at Interactive Brokers Group.

About 5,000 June $45 strike calls were bought at an average premium of $1.80 each, and 5,000 calls were sold at the higher June $50 strike for an average premium of 68 cents each.

Since the net premium paid to initiate the bullish stance amounts to $1.12 per contract, the strategy is betting that Cree shares would surge 12.9 percent over the current prices at $40.85 to exceed the average break-even point on the spread at $46.12 by June expiration, according to Duffy.

Cree shares dropped nearly 14 percent a day after reporting earnings in January and lost 5.5 percent a day after releasing results in October 2010.

Original Article – http://www.reuters.com/article/2011/04/19/earnings-cree-options-idUSN1927579420110419

04/27/2011
U.S. News & World Report
Baden, Benjamin

Professional managers use it as a short-term trading opportunity. Should you?

The market has been on a fairly steady upward trend this year, except for a stumble in mid-March following the devastating earthquake and ensuing tsunami in Japan. So far this year, the S&P 500 has returned about 7 percent, and the Dow Jones Industrial Average is up almost 9 percent. That’s likely a reason many investors have become complacent, which is reflected in one of the market’s most closely watched indicators, the Chicago Board Options Exchange Volatility Index, or VIX for short.

The VIX uses options prices to measure expected volatility in the S&P 500 over a 30-day period. It’s often referred to as the “fear gauge” because it measures how fearful or complacent investors are at any given time. Professional money managers often use the VIX as a hedge against volatility because the VIX generally moves in the opposite direction of the S&P 500. Investors can follow the VIX on the Chicago Board Options Exchange website.

This year, the VIX peaked around 31 in March after the earthquake in Japan, but it recently hit lows not seen since the last bull market in mid-2007. The VIX closed at 14.69 on April 21, the lowest level since July 2007, according to TrimTabs Investment Research. Some experts say that low number indicates that investors have become far too complacent in a market that faces many challenges, including higher oil prices, unrest in the Middle East, and growing inflation concerns globally.

“The market has moved up almost every day, and it’s very easy to get lulled into that complacency,” says Harry Rady, CEO of Rady Asset Management, a San Diego, Calif.-based investment management firm. “But that’s the time when you want to have your guard up, because the market has a way of chewing investors up and spitting them out when they’ve been lulled to sleep.”

Rady says options are currently cheap, so investors should take advantage. “I would argue that the risks and the potential for geopolitical economic shocks are significantly greater than 2007,” he says. Therefore, he expects an uptick in the VIX in the near future. He uses exchange-traded notes, including iPath S&P 500 VIX Short-Term Futures (symbol VXX), to invest in the movements of the VIX. This exchange-traded note, which is a complex debt security that trades like an exchange-traded fund, tracks the S&P 500 VIX Short-Term Futures Total Return Index. It usually goes up or down about half as much as the VIX over a given time period, Rady says.

It’s important to read the VIX numbers in context. Ryan Detrick, senior technical strategist at Schaeffer’s Investment Research, says during the last bull market, which lasted from roughly mid-2004 through mid-2007, the VIX trended in the 10-to-15 range. “During the last bull market we saw, a VIX of 15 was actually high,” he says. Detrick says he’s currently bullish on the market and expects the VIX to continue to fall further, closer to 10.

While it may be beneficial to follow the VIX index to get a read on the level of fear in the markets, it may have limited appeal to individual investors. For starters, experts agree that investing directly in the VIX through exchange-traded notes is only for the most experienced investors. (Currently, there are no exchange-traded funds that invest directly in the VIX.) “Any way you slice it, this isn’t a security that can be bought and put away,” Rady says. “It has to be traded.”

Christian Magoon, CEO of asset management consultant firm Magoon Capital, argues that investors only benefit in times of chaos in the markets. “If you look at the overarching history of the equity markets, there has been extreme events, whether it’s a 9/11 or the Japanese sell-off … but the market eventually always recovers,” he says. Spikes in the VIX are usually short in duration, and they generally don’t affect your investments over the long term.

Still, it may be useful for investors to follow the movements in the VIX because they can be a contrarian indicator. Magoon says investors should use the VIX like meteorologists use a barometer for predicting the weather. “It’s one of the vital signs of the market that gives you a look into the psychology of the market,” he says.

Investors can follow the VIX just like they can follow investor sentiment surveys, like the one that American Association of Individual Investors releases each week. When the VIX is low relative to historical standards, it may be a warning sign that a sell-off is near, but most experts say it’s probably not in your best interests to try to time those spikes.

Original Article – http://money.usnews.com/money/personal-finance/mutual-funds/articles/2011/04/27/what-investors-can-learn-from-the-vix

Remember President Obama’s stimulus plan? See what Harry Rady‘s thoughts were back in 2009.