Volatility Clouds 2012 Predictions

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When it comes to predicting the future, investors might as well be throwing darts at a board, says Brett Arends of Marketwatch -- they might even have better luck.

That's because when it comes to analyst predictions for the year ahead, there is no guarantee. A year is a long time, and most of the surprise bumps in the road can't be fully accounted for.

Making predictions
Reuters reports Blackstone Vice Chairman Byron Wien, among Wall Street's best known prognosticators, presented his 10 surprising predictions for 2012. They go so far as to suggest oil prices will drop to $65 a barrel.

Furthermore, "BlackRock equity strategist Bob Doll foresees double-digit U.S. stock returns, though corporate earnings growth could lag expectations. And one well-known forecaster declared 2012 too hard to predict."

Facing the music
Perhaps this "well known forecaster" has faced the music -- analyst top picks have rarely been the best guideline.

For example, at the start of 2011, the S&P 500 stocks with top buy ratings would have returned -3.5% if you kept the dividends and cashed out at the end of the year.

"Over the previous five years -- you can now make that six -- Wall Street analysts 'top 10' stock picks have actually earned you slightly less over time than the index," says Arends.

Interestingly, in 2011 Wall Street's most hated stocks only fell 4.3%.

"In other words, the 10 stocks that analysts loved the most beat the stocks they hated the most by an average of less than 1% ... Historically, this, too, is something of a pattern. In previous years, the 'most hated' stocks hadn't been much worse than the index, and in several years had done much better."

Business section: Investing ideas
So, how can you protect your portfolio against rising stock market volatility? One way is to search for the stocks that have a high positive correlation to the VIX index, which measures the implied volatility of S&P 500 index options.

In other words, these companies tend to rise if overall market volatility rises.

To refine the list, we also screened for stocks that have seen a decrease in the number of shares shorted (i.e. a decrease in bets that these stocks will decline).

This is significant, especially when you consider that short-sellers tend to be more sophisticated investors (due to the fact that they require strict credit approval to perform these trades). So if these investors are turning bullish on a stock, it's worth paying close attention.

Short-sellers seem to think there's more upside than downside to these names, and past price action shows that these stocks do well if volatility rises. Should any of these names be on your watch list?

List sorted by correlation to the VIX index. (Click here to access free, interactive tools to analyze these ideas.)

1. Complete Genomics (Nasdaq: GNOM  ) : Develops and commercializes a DNA sequencing platform for human genome sequencing and analysis. The stock's correlation to the VIX index stands at 0.715. Shares shorted have decreased from 1.73M to 1.53M over the last month, a decrease which represents about 1.14% of the company's float of 17.55M shares.

2. ReachLocal (Nasdaq: RLOC  ) : Provides a suite of online marketing and reporting solutions for the small and medium-sized businesses (SMBs) in North America and internationally. The stock's correlation to the VIX index stands at 0.695. Shares shorted have decreased from 1.64M to 1.33M over the last month, a decrease which represents about 3.32% of the company's float of 9.33M shares.

3. Invacare (NYSE: IVC  ) : Designs, manufactures, and distributes medical equipment and supplies for the non-acute care environment, including the home health care, retail, and extended care markets. The stock's correlation to the VIX index stands at 0.691. Shares shorted have decreased from 2.51M to 1.94M over the last month, a decrease which represents about 1.97% of the company's float of 28.90M shares.

4. Cadence Pharmaceuticals (Nasdaq: CADX  ) : Focuses on in-licensing, developing, and commercializing product candidates principally for use in the hospital setting in the United States and Canada. The stock's correlation to the VIX index stands at 0.66. Shares shorted have decreased from 7.98M to 7.10M over the last month, a decrease which represents about 1.98% of the company's float of 44.42M shares.

5. FormFactor (Nasdaq: FORM  ) : Designs, develops, manufactures, sells, and supports precision and high performance advanced semiconductor wafer probe cards. The stock's correlation to the VIX index stands at 0.657. Shares shorted have decreased from 2.74M to 2.21M over the last month, a decrease which represents about 1.05% of the company's float of 50.26M shares.

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.

List compiled by Eben Esterhuizen, CFA. Kapitall's Eben Esterhuizen and Rebecca Lipman do not own any of the shares mentioned above. VIX and Short data sourced from Yahoo! Finance, all other data from Finviz

The Motley Fool owns shares of FormFactor. Motley Fool newsletter services have recommended buying shares of FormFactor and ReachLocal. Motley Fool newsletter services have recommended creating a bull call spread position in FormFactor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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