How to Survive the Stock Market's Wild Ride

The stock-market roller coaster has been wild enough to make even the most stoic, stiff-necked investors queasy. After falling in 10 out of the last 11 trading sessions, the stock market plunged more than 500 points Thursday, making it the worst day for the Dow since Oct. 22, 2008, the day that marked the beginning of the global financial crisis. On Thursday, the index lost 4.3% -- erasing all the gains for the year -- to end at 11,384.

What's stoking the volatility? The U.S. dodged the default bullet, but not everybody is impressed. "The negotiated debt-ceiling settlement is being seen by world's financial markets as a smoke screen," says James DiGeorgia, publisher of the Gold and Energy Advisor newsletter. "No matter how many times my fellow Republicans repeat the mantra that Washington has a spending problem, not a revenue problem, the truth is we cannot make a dent in the national debt unless we reduce spending and raise revenues.

"Without swift tax reform lowering corporate and individual rates in exchange for eliminating the special-interest patchwork of tax breaks and subsidies, we're going to continue to see the national debt spiral higher and the dollar weaken."

The fact remains that the U.S. economy is not just lackluster, but flirting with recession part deux.

"Continued weakness has shown in the recent economic numbers. The [gross domestic product] at 1.3% is at a recessionary level and not nearly what is necessary to reduce the compounding effect of our deficit," says Jeff Sica, president and chief investment officer of Sica Wealth Management. "Downward revisions on economic numbers make lagging indicators even worse, suggesting what we always believed: we never left the recession."

Unemployment remains high, even though it fell to 9.1% in July, from 9.2% in June. And even worse, job cuts have surged 60%, which will boost unemployment much higher, Sica says.

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Not Alone

At least the U.S. isn't alone. "The European economy is collapsing," Sica says.

Europe is addressing its fiscal and monetary problems way too slowly, DiGeorgia says. Greece, Italy, Spain and Portugal are in seriously bad shape. Banks in Europe are on the hook, he says, as are many banks throughout the U.S. that have been playing interest-rate arbitrage, borrowing at a quarter of a percent and lending to Italy for 6% and Greece for 9%, for example.

"For anyone in the know, its a catastrophe in the making," Sica says. "Bottom line: A financial crisis worse than the one that took place in 2008 and 2009 could ignite at any moment." And because many Europeans take the month of August off, the first emergency meeting to address the euro and the danger isn't scheduled until Sept. 6th, in France. Europe is a dark cloud getting darker by the day, Sica says.

Another concern is China, points out Matt Freund, senior vice president of investment portfolio management at USAA. What if the Chinese economy falters -- a scenario that seems much more likely than it did as 2010 ended? Real estate and construction have become dominant sectors in China's economy, but easy credit and speculative building may be creating a surplus in luxury apartments and other properties that sets the stage for a major correction.

A reversal of China's economic fortunes could have wide-ranging effect. It could lower demand for industrial and construction equipment, dampening revenues for the companies that make it; weaken demand for commodities, which could pressure the emerging-market economies that depend on them; and reduce overseas profits for large multinational corporations as growth stalls around the world.

What are Investors to Do Now?

A confluence of such factors are creating plenty of uncertainty. Investors are wondering what in the world they can expect from the market for the rest of this year.

"Given the debt deal, the likelihood of another stimulus package is decreased," says Steve Wood, chief market strategist for Russell Investments.

And that will slow the recovery, says John Liu, president of Firstrade, an online broker. "Without government help, the market is going to get worse before it gets better," he says. "It doesn't mean it won't get better, it will just take longer."

Sica predicts that the market will decline 15%-20% by the end of the summer. Given the economic headwinds, it's hard to envision a return to a robust and steadily growing economy anytime soon.

Investors should expect the recovery to remain choppy and uncertain, marked by below-average economic growth and periodic setbacks -- including the potential for another recession, Freund says.

For sure, the outlook suggests investors should tighten their seatbelts and brace themselves for one jolt after the other. How can you protect yourself? Here's what the pros are suggesting:

Keep your cool

"Don't panic, and keep your emotions in check," says Thomas Yorke, a Covester model manager and managing director of Oceanic capital Management. "These movements should flush out some of the more leveraged players and provide an opportunity to make some selective buys at a significantly lower levels. In situations like this, most investors are more likely to sell their best performers and hold their worst -- the trading in gold today being a prime example of that behavior. When you are ready to make some adjustments, make sure you pitch your poor performers and opt for the market leaders who apt to recover more quickly."

This is the time to re-evaluate your portfolio and determine how diversified you truly are, Yorke advises. But keep in mind that the correlations between different asset classes will converge at times like these, when the market is moving downward so strongly, he says. "You should study what classes performed best and plan to increase your exposure to them when things start to return to normal," he says. "Doing this during high-stress periods will more likely have you buying things too expensively and selling things too cheaply. Your goal should be to create the proper asset allocation and understand that

over time this more balanced approach will achieve a better 'risk adjusted' return and enable you to sleep better at night."

If you are a long-term investor, take a deep breath and stay the course, says Mark Fissel, a certified financial planner with Beacon Hill Investment Advisory. From the standpoint of price-to-earnings ratios, or stock prices compared to company earnings, the stock market is the cheapest its been since 1990. So, yes, there's great uncertainty, but that also means there's an opportunity to make money. By the time the sky is blue, the market will have already gone up, Fissell says.

Fred Dickson, senior vice president and chief investment strategist with D.A. Davidson & Co., has similar advice to investors: Find the upside. Use the recent 10% market dip to invest in high-quality stocks that have a long history of increasing dividends, he says.

Get Defensive

Sock away enough cash to fund at least three months of cash-flow needs and invest that money in a high-grade

corporate-bond mutual fund, suggests Timothy Speiss, partner and chairman of EisnerAmper.

Tuttle Wealth Management switched 50% to 80% of its portfolio to cash and Treasuries on the Monday morning before the first crash, says Matthew Tuttle, a certified financial planner with the company. He didn't predict what was going to happen, he says, but the trend of the market was indicating that was the right move. "We are now pretty much completely hedged and making nothing while buy-and-hold investors are losing their shirts," he says.

Some advisors are slicing off 20%-40% of portfolios into annuities. Depending on the annuity type, it could provide steady flows of income for years -- or even for life -- and reduce the risk that investors could run out of money. Annuities make sense because just one market loss can change how long your retirement income lasts. Especially for those who are near retirement or already retired, says Jonathan Gassman, a certified financial planner with Gassman & Kolody.

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Despite the recent run up in precious metals and related stocks, investors should consider allocating a significant portion of their portfolios to those investments, says James Dailey, chief investment officer of Team Financial Managers. "In my opinion, they remain underowned and have not been embraced by institutional investors, despite being in a bull market for 10 plus years," he says. "They offer important diversification benefits, as well as protection against devaluing currencies, though they are likely to be volatile."

Meanwhile, he warns investors against government bonds. "Rushing into bonds is extremely dangerous, in my opinion, given how governments are likely to respond," he say

Like your mother told you, expect the worse and hope for the best. Says Jay Ferrara, investment officer at Farmers and Merchants Trust Company, "Surviving the remainder of 2011 could be considered a success story."