What Correction? 1 Key Sign Investors Remain Complacent

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

The losing streak for the U.S. stock market could reach five days today if current losses in the Dow Jones Industrials and S&P 500 don't reverse themselves. That pullback has renewed warnings from experts that the market is long overdue for a correction of 10% or more. Yet when you look at the CBOE's Volatility Index (VOLATILITYINDICES: ^VIX  ) and the exchange-traded products iPath S&P VIX ST Futures (NYSEMKT: VXX  ) and VelocityShares 2x VIX ST (NASDAQ: TVIX  ) , you can see that traders aren't taking threats of an imminent pullback seriously.

Much ado about nothing?
Based on all the hype about the stock market's drop lately, you might expect the so-called Fear Index to have vaulted higher. Yet even though the Volatility Index has risen from the 12-13 range to close to 15, the gains haven't led to a huge reaction from trend-sensitive investors. That might well be because gains for the exchange-traded products have been more muted, with the iPath ETN up about 5% from its November lows and the VelocityShares leveraged offering jumping about 9%.

It's easy to understand why volatility-hungry investors remain incredibly frustrated by the market. Even with their recent gains, these volatility-based investments have plunged this year. The decline in the Volatility Index itself from 18 to just below 15 represents a drop of less than 20%, but the unleveraged iPath ETN has lost more than 60% of its value and the VelocityShares ETN has fallen more than 90%. Both have had to do reverse stock splits in order to sustain their share prices at reasonable levels.

When you consider just how gentle the past week's decline has been, the lack of fear in the market is understandable. It's been just a couple months since the Dow posted a five-day consecutive losing streak, with the attendant drop of about 400 points looking more severe than what we're likely to see this time, based on the 200-point drop over the past four days.

Until the market puts together a more convincing downward push, investors shouldn't expect to see much on the volatility front. Indeed, the best way to play volatility lately has been from the opposite side, with the VelocityShares Inverse VIX ST ETN (NASDAQ: XIV  ) having almost doubled in price so far this year. As long as investors remain as complacent as they are now, that's the only volatility-linked product likely to produce any gains.

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