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Focus on Long Term, Not Market Volatility
AZ Central - Russ Wiles

It's baack!

Stock-market investors are getting their first sustained taste of downside volatility in a while, and most probably aren't savoring the experience.

The Dow Jones Industrial Average has surrendered roughly 1,000 points in the past month since peaking at 14,000. Over that stretch, the indicator lost at least 100 points on nine separate occasions.

What's going on?

Rising mortgage defaults, hedge-fund cash-flow troubles and other signs of a credit crunch are the common explanations. The fear is that these could crimp consumer spending, damage corporate profits and slow the economy.

As a result, investors are trying to make sense of the new landscape. It's not yet clear how exposed various corporations are to the mess, how consumer spending will be affected and what all that means to the big economic picture.

"Wall Street and the credit markets hate uncertainty, and they fear a lack of transparency," observed Scottsdale investment adviser Jay Penney.

But there are other factors at work, too. Some blame hedge funds for the turmoil, as some have been forced to sell stocks to cover mortgage losses in their leveraged portfolios.

Money manager David Brady of Brady Investment Counsel in Chicago cites the Securities and Exchange Commission's July 5 elimination of the "uptick" or "tick test" rule as a contributory factor. This rule, in force since 1938, required an investor to bid up a stock's price before someone else could sell it short.

"Now a trader does not have to wait for a stock to trade up before selling short," wrote Brady in a report. He thinks the rule's elimination will keep market volatility high.

Then again, stocks were due for some backing and filling after an extraordinary four-month rally that saw the Dow surge 2,000 points. Besides, the May-October stretch tends to be much weaker than the remaining months of the year, according to research by the Stock Trader's Almanac 2007.

Market changes seem more drastic in part because the overall numbers have gotten so much bigger. A 1 percent daily move today represents a swing of roughly 130 Dow points. Four years ago, a 1 percent swing was worth 90 points.

But the movements aren't just relative but reflect higher absolute volatility, too. The VIX, or volatility index, compiled by the Chicago Board Options Exchange has shot up to 52-week highs in recent weeks.

For mainstream investors, there's no magic formula for handling the bumpier ride. If you seek the solid long-term gains the market historically has delivered, you should be prepared for occasionally nasty setbacks.

"If you can't accept 5 or 10 percent downturns in your portfolio, maybe stocks shouldn't be represented in your portfolio," said Rich Rosso, a certified financial planner with Charles Schwab in Houston.

But assuming you are willing and able to hold for the long haul, Rosso thinks it's wise to rebalance your portfolio from time to time by moving modest amounts of cash from investments that have held up well to those that have stumbled.

Jacob Gold, a certified financial planner in Phoenix, is cautioning clients not to make big portfolio shifts now, noting the economy remains solid with stocks looking more like bargains based on price-earnings ratios and other measures.

"Times are tough right now, but in moments like this you have to trust your education of the financial markets and stay focused long term," Gold said. "I would not do my clients justice if I began to fold on my strategy."

For the most part, mainstream stock and mutual-fund investors have tended to avoid making drastic moves during sharp market retreats, according to research by the Investment Company Institute that examined several swoons.

Jack Ablin, chief investment officer at Harris Private Bank in Chicago, sees investors becoming more conservative in evaluating risk, and this more cautious attitude might mute any eventual recovery. But he also views wild market swings as potential turning points.

"Looking back, volatility spikes were more closely aligned with market bottoms than market tops," Ablin wrote in a report that highlighted similar peaks in 1998 and 2002, both of which wound up as good times to buy.

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