Wall Street’s fear index, aka the CBOE Volatility Index (VIX), has surged higher over recent months. After starting the year at a level of 16, it is now nearly double that figure, which shows that investors have become more fearful.
Of course, that is somewhat unsurprising. Rising inflation, the prospect of tighter monetary policy and heightened geopolitical tensions have prompted many investors to reassess their views on the stock market’s future.
In many cases, this may mean they decide to avoid purchasing stocks for fear that the situation could deteriorate. They may prefer to wait for a period where investors are more sanguine about the economy’s prospects and the stock market’s outlook. They may feel that doing so provides them with a lower chance of losing money and a greater chance of generating capital growth from their investments.
Fear brings opportunity
In my opinion, such a strategy would be highly illogical. The goal of investors is to buy stocks at low prices and sell them at higher prices. Therefore, with many high-quality companies now trading at large discounts to their intrinsic value estimates and/or historical average valuations, this could be an excellent opportunity to buy stocks. In many cases, stocks now offer significantly more potential for capital growth than they did a number of months ago.
This viewpoint has previously been discussed by Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) chairman Warren Buffett (Trades, Portfolio). As he once said: “I will tell you the secret to getting rich on Wall Street. You try to be greedy when others are fearful. And you try to be fearful when others are greedy.”
Short-term unknowns
The stock market’s short-term performance is highly unpredictable. Just because share prices have fallen substantially in a short space of time does not mean they will continue to decline, but it doesn't mean they will rise either. They could move dramatically lower or higher. If they move higher, investors may feel like they are missing out, and if they move lower, investors may become even more fearful.
It's important to keep in mind, falling share prices do not equate to a permanent loss of capital in and ove themselves. Investors who buy shares now can hold them throughout the current period of economic challenges without crystallizing their losses. If they are comfortable with the price paid and in the financial strength of their holdings, then over the long run, they are likely to make attractive returns as the economic outlook improves and the stock market recovers.
Risk management
Clearly, not all shares are appealing at the present time. Some companies face difficulties that are unlikely to improve. For example, highly indebted companies are set to experience higher interest charges, which could affect operations.
Therefore, it is important to not only purchase high-quality companies but also to diversify across multiple industries and geographies. In doing so, investors can further reduce the risks they face and increase their chances of successfully capitalizing on heightened investor fears.
