Handling Stock Market Volatility

Think again.

Remember when U.S. stocks hit a record high? Of course you do; it happened just three weeks ago. Now Wall Street is up against the wall. The Dow Jones Industrial Average closed at 13239 on Friday, 5.4% below its 14000 peak on July 19. The way down has been a rocky stretch of cliff-hanging rappels, with high bounces and hard bumps as investors grapple for a foothold. With stocks in Europe and Asia also getting hit, it seems there's no firm ground in sight. "This is what happens when markets get nervous," said Jim Peterson, a vice president at the Schwab Center for Financial Research. "People are pulling the trigger. It's crazy." Friday's trading brought some needed relief to a pressure-filled week for stock investors. The Dow, a benchmark index of 30 big U.S. companies, lost 31 points in a seesaw session where the index briefly was down more than 200 points. This small decline was a welcome scenario, coming a day after the Dow's 387 point plummet - its second-worst session of the year. But Federal Reserve action to support U.S. banks on Thursday and Friday helped boost investors' confidence. The Dow even managed to cap a wild week in positive territory, up 0.4%; while the Standard & Poor's 500 Index fared better, up 1.4%. Still, it's clear that volatility is back with a vengeance, accompanied by its rogue mates, uncertainty and fear. In 11 of the past 16 trading days, the Dow has finished with moves of 100 points or more. What's causing this turmoil? The end of cheap and easy borrowing - part of the fallout from the subprime mortgage mess - has coincided with slower corporate earnings and weaker consumer spending. This perfect financial storm is causing investors worldwide to rethink the risks they've taken in stocks and bonds. Many shareholders haven't stopped to think at all - they're just selling. At such times, even professional money managers are prone to make emotionally charged decisions. And that's exactly what investment strategists are telling you to avoid right now if you have a longer-term time horizon. "You can't focus on what's happening on a daily basis," Peterson said. "Look at your portfolio. If it has the right risk tolerance, bite your lip and go through it." Ouch. It's hard to be stoic when even the most seaworthy stocks are being tossed around. But Exxon Mobil Corp. (XOM), the energy giant and the biggest U.S. stock, recovered Friday from a drumming on Thursday, as did financial services powerhouses Citigroup Inc. (C) and JPMorgan Chase & Co. (JPM) Other widely owned stocks were pinned down, including conglomerate General Electric Co. (GE) and home lenders Countrywide Financial Corp. (CFC) and Washington Mutual Inc. (WM) Energy and financials are highly sensitive to any economic slowdown, but even promising technology bellwethers - whose businesses are unrelated to the mortgage meltdown - were being thrown about during the week, with Google Inc. (GOOG) rising 2.5%, Microsoft Corp. (MSFT) falling 0.9% and Intel Corp. (INTC) up slightly. "Investors are sitting on their hands," said David Joy, chief market strategist at RiverSource Investments. "They're saying 'I'm in no hurry.'" Jeremy Grantham, chairman of institutional money manager GMO LLC, sees the tug-of-war between bulls and bears continuing over the next year. "I expect the market will fight against going down, and keep on fighting," said Grantham, who oversees the investment strategies of the Boston-based firm. Grantham predicts the bears will gain the upper hand after next year's presidential election. "Corporate profits are up but margins are down," Grantham said. "If they continue to fall, the market can go down a lot." How much? Grantham says the S&P 500 could lose 40% between late 2008 and the end of 2010.

Storm Watch

What, if anything, should you do now with your money? Grantham and other investment strategists have been advising for some time, in fact, that investors stay broadly diversified but tilt stock portfolios to the market's largest, most globally focused companies. "Make sure the shares you own are the blue chips," Grantham said. Here's why: Corporate giants enjoy a worldwide customer base and can borrow - if they borrow much at all - on the most favorable terms. Many smaller companies, in contrast, are deep in debt and rely on narrow sources of revenue. "During periods of uncertainty, investors want to go where returns are relatively certain," said Kari Pinkernell, senior investment strategist at Merrill Lynch & Co. "People are more defensive and sniff out quality." Health care and consumer staples, for example, are two sectors that are relatively stable and attractively valued, according to Merrill research. Plus, these stocks have held up better than others in the recent decline. Only weeks ago, investors were willing to shoulder higher-risk stock and bond plays. It will likely take many months for markets to work through this crisis, and a properly diversified, globally oriented portfolio can smooth the rough patches. Spreading your money across different types of assets is the best way to reduce investment risk. If market volatility makes you nervous, it probably means you're not diversified enough or that your investments are mismatched with your tolerance for risk. So review your portfolio allocation and if necessary, put it on surer footing. Understand that time in the market is more important to your returns than timing the market, and as a result longer-term focused investors have an edge on shortsighted traders. Keep in mind that even with the market's recent upheaval, the S&P 500 is still up almost 17% in the past 12 months. "The danger you have is overreacting," said Schwab's Peterson. "This is where discipline gets tested."