Column: How long will investors love volatility?

There is no hot or new theme like Internet or Convergence to describe this market. The best description is volatility, especially technology volatility.

Daily volatility has been rising in the technology sector continually since 1995. Investors' past reaction to this much volatility was to seek other investments, but so far not this year.

Instead, investors continue to pour money into the aggressive growth and technology areas. The new risk is not risk of loss; it's the risk of missing out on the next big thing. As a class, investors are still equity believers - and even bigger believers in the long-term outlook for the technology sector. There is always a new theme or momentum to play, whether it's infrastructure or net or whatever.

What investors have to start thinking about is what equities are really worth and whether there are opportunities outside technology. A two-tiered return market created a two-tiered valuation market. There are the lower than 1998 P/E ratios available for most of the equity universe, and then there is that select group of triple-digit P/E ratios of the few. Is the valuation anomaly at the lower end of the universe, and do these stocks begin a new upward valuation cycle? Or did the valuation anomaly occur from November to March and make the normal 50 times earnings companies become 150 times earnings with their next move back down to the normal? If mean reversion is to remain a fundamental tenet of financial markets, one of these has to occur.

The market suffered by any definition in the 2nd quarter. The S&P 500 -2.9 percent return was better than the Dow Jones -4.1 percent return and the Russell 2000 return of -3.7 percent. Year to date, only the Russell 2000 has posted a positive return, one of 3.1 percent on the strength of the incredible growth move early in the year and the stability of small value from March forward. Year to date, both the S&P 500 cap and equal- weighted are slightly negative at -0.5 percent and -0.2 percent.

Given the turmoil in the technology market in March to April, a slightly negative return does not seem so bad. The number is only bad in comparison to expectations of 20 percent per year returns. With all the technology problems, the very small negative returns mean there was strength in other areas of the market.

The market has had one dominant trend recently, volatility. Normally, volatility sends investors fleeing in the other direction. Investors have stayed in for one reason - they believe they cannot afford to miss the next huge rally when it comes. Flow of funds data show that investors continue to increase commitments to the riskier assets in the U.S. market and are willing to decrease diversification.

However, the data also show that diversified portfolios have reduced volatility and increased returns by staying committed to all asset classes this year. While individual investors have welcomed more risk, many investment managers have increased portfolio risk. The indices' sector distribution data have managers seeing the rising weight of technology in the indices, and in the name of tracking error control they increased positions.

The growth index data are heavily skewed by the valuations and weights of the technology sector, which is forcing managers to choose between historical portfolio risk controls and current index tracking controls. If the highest valuation growth stocks suffer a valuation correction anything like the rest of the market did since April 1998, low tracking still has big absolute risk.

Many of the market excesses are smaller now than six months ago. The IPO market is quieter, with a mix of winners and losers; margin and day trading are not quite so exciting; and the performance-doubling horizon is no longer than one week again.

With volatility also comes the hope that a daily or couple of days trend can be extended into a longer rally or a resumption of the November to March behavior. However, something keeps coming up to keep a lid on the euphoria, like an analytical and fundamental research report on an Internet stock or more shares being sold from all the old IPOs to increase supply.

While there may not be one big thing in the market like last year, it really hasn't been all bad. There are many positive industry dynamics and individual corporate achievements that get rewarded. The right stocks will get rewarded, and the truth will be revealed about a lot more eventually. For more information, call me, Bill Creekbaum, CFP, at 689-8720 or e-mail me at william.a.creekbaum@rssmb.com

William Creekbaum, MBA, CFP, a Carson City resident, is senior consulting group associate of Salomon Smith Barney, a financial services firm serving Northern Nevada.