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Investors’ resolve will be put to a test this week

The stomach-churning turmoil that revisited the stock market last week may not be gone yet.
/ Source: The Associated Press

The stomach-churning turmoil that revisited the stock market last week may not be gone yet.

That's not to say investors should brace for another dizzying drop like the intraday 1,000 point plunge in the Dow Jones industrial average on Thursday.

Lingering uneasiness over the sudden decline seems likely to muzzle buying activity, however, over the coming week at a time when Europe's sovereign debt crisis is still unfolding. Further trouble in Greece or elsewhere could re-ignite selling by investors who just saw the stock market's entire 2010 gain of 8 percent wiped out in a four-day losing streak.

"Nerves are frayed and fragile and exposed right now," says Rob Lutts, president and chief investment officer at Cabot Money Management in Salem, Mass. "The market is under the control of the short-term investor. Longer-term investors are sitting on the sidelines."

Those short-term investors so far are choosing to "sell in May and go away," as an old Wall Street adage goes. The month is off to its worst start ever, with the Standard & Poor's 500 index down 6.4 percent and having shed $685 billion.

Which direction the market goes from here depends on investors' emotional stability, according to Liz Ann Sonders, chief investment strategist for brokerage Charles Schwab & Co.

"You probably have a number of investors who think, 'Oh God, we have another '08 scenario unfolding here,' and would be quick to pull the trigger" and sell if the volatility continues, she says.

Financial advisers are counseling investors not to panic or overreact to any continued price decline.

Apart from Greece, they note, economic indicators underpinning the stock market have been improving. Employers added a net 290,000 jobs in April, the most in four years. Consumer spending and retail sales have steadily perked up. And stronger-than-expected corporate earnings suggest hiring will accelerate.

"People are nervous for a lot of reasons, but they should keep their wits about them and focus on the fundamentals," says Carol Clark, investment principal at wealth management firm Lowry Hill in Minneapolis. In the long run, they'll look back at this as a great buying opportunity.

Even before the sudden plunge on Thursday, the market was down more than 400 points over concerns the economic problems in Greece would spread. Still, that should be put in perspective. The U.S. market endured a 19 percent correction during the Asian economic crisis in 1998, Sonders notes, but that proved to be only a brief pullback before it went on to post robust gains.

Still, investors who can't forget the beating their stock portfolios took starting in the fall of 2008 may not be willing to stay the course.

Many already were wary about the rapid pace of the market's recovery. After bottoming out on March 9, 2009, the S&P 500 rocketed up 80 percent to its most recent high on April 23.

It doesn't help engender confidence in the market that Thursday's sharp drop occurred without warning and was blamed on a computerized selloff possibly caused by a simple typographical error. Market regulators are still investigating the cause and a House subcommittee plans to hold a hearing on Tuesday.

Adding to the uncertainty is the pessimism of some expert analysts who think that the problem with European banks is bound to worsen, jeopardizing the global recovery.

Dave Wright, lead portfolio manager of the Sierra Core Retirement Fund in Santa Monica, Calif., says the recent spate of selling is a just a taste of what's to come.

"I think you'll see much more volatility ahead," he says. "It's possible that the Dow could have one final upward rally, but the next 20 percent move is not likely to be up."

The stock market's fear gauge, known as the VIX, also points to market volatility for at least another month. It soared 64 percent on Thursday and Friday to 40.95, about double its historic average of 19.

Whether jitters translate to more selling remains to be seen. The VIX is just where it stood last April, as the bull market was just gathering momentum.