After Downgrade, All Signs Point to Sharp Decline When U.S. Market Trading Begins

NEW YORK – It's likely going to be a harrowing day for investors.

All signs point to a sharp decline when trading begins in U.S. markets this morning. Overnight, international markets fell amid anxiety over the European debt crisis, Standard & Poor's downgrade of U.S. long-term debt late Friday and concerns about the U.S. economy.

"We are in uncharted territory and, therefore, should all brace for volatility over a number of days, if not weeks," said Mohamed El-Erian, CEO and co-chief investment officer of PIMCO, the giant bond mutual fund company.

Among the major Asian stock indexes, Hong Kong's Hang Seng was down 4.1 percent by midafternoon and South Korea's Kospi shed 3.8 percent after earlier diving nearly 7 percent. Japan's Nikkei 225 stock average dropped 2.8 percent.

Wall Street futures sank further into the red as Asia's day progressed. Dow futures were down 289 points, or 2.5 percent, to 11,113 and broader S&P 500 futures sank 33.3, or 2.8 percent, to 1,164.50.

"There's a lot of fear and misunderstanding and confusion, and all that could come out in the stock and bond markets. I don't think it takes much to unnerve investors given the current environment. I think anything could drive investors to sell, given how fragile sentiment is," said Mark Zandi, chief economist at Moody's Analytics.

Investors now face a difficult choice. Conventional wisdom says that mom-and-pop investors tend to buy and sell stocks at exactly the wrong time -- they lose big by selling too late and then buy too late into a rally and miss gains. Of course, investors who sold just as the financial meltdown in 2008 was starting, cut their losses. In recent days, there have been signs that plenty of investors are doing just that. Money is flowing out of stock funds and into safer investments such as gold and U.S. Treasurys. Many investors are just converting their investments into cash and waiting out the turmoil.

For their part, financial planners say people who stick with their investment strategy will likely see their portfolios recover in the long run.

"The whole reason for having an investment plan is to make it easier to know what to do in times like these," notes David Yeske, managing director of Yeske Buie, an investment firm based in San Francisco.

Still, that can be difficult to remember when faced with a seemingly endless stream of grim news.

Standard & Poor's downgraded the country's top AAA rating for long-term debt for the first time in history on Friday. The ratings agency lowered the rating one notch to AA+. It said political fighting in Washington raised concerns about the government's ability to solve its budget and deficit problems.

Just a day earlier, the Dow Jones industrial average fell 513 points, its biggest drop since the 2008 financial meltdown. The plunge contributed to a nearly 10 percent slide in the Dow over the past two weeks. One reason for the drop: Italy looks like it could be the next European country to need a bailout. And that raised concerns about the health of the global economy.

One bit of positive news for investors: The Group of Seven industrial nations said late Sunday that all necessary measures would be taken to support financial stability around the world. The G-7 statement came after an emergency conference call to discuss the debt crisis in Europe and the action by S&P on U.S. debt.

Still, last week's swoon in stocks likely knocked many portfolios out of balance. For example, younger professionals might have built a portfolio so it would be 70 percent in stocks. But that share has probably fallen as the market did. These investors should consider shifting more money into stocks to get back into balance, financial planners say.

The prospect of buying stocks, even at cheaper prices, is daunting. The more natural instinct when the market is undergoing turmoil is to sell.

"But if you sell now out of fear that the markets won't recover, you'll be selling low and losing money," notes Ric Edelman, CEO of Edelman Financial, based in Fairfax, Va. "Investors who are fair-weather friends are the ones who lose the most money. Profits are earned when the market is declining."

The past few weeks underscore the importance of rebalancing regularly and frequently, especially as you get closer to the time when you'll need your money. Experts say those nearing or already at retirement age shouldn't have been heavily invested in stocks, and so the recent selloff shouldn't have had a significant event.

If the thought of buying stocks in this climate is unnerving, keep in mind that the majority of portfolio changes the past two years have gone in the other direction. Portfolios have become stock-heavy because the market has soared. Even with last week's drop, the Standard & Poor's 500 index is still up 77 percent from its bottom in March 2009. It's also down 23 percent from its high set in 2007.

Buying stocks now to rebalance will help you keep your long-term strategy. But it needs to be done carefully. Look for stocks that are expected to do well for the next five to 10 years. Look for stocks that pay steady and rising dividends.

And don't try to make a quick buck because prices look low.

Cliff Caplan, wealth manager at Neponset Valley Financial Planners in Norwood, Mass., said those looking to make money in the short term may end up getting burned.

"You can't assume anything," he said. "To make a prediction in the short run is fool's game right now."