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Surviving the Market If the Slide Continues
By Ali Jaffery

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The stock market's carnage continued last week, leaving many investors wondering just how much worse things can get.

 

[Hanging On]The outlook certainly isn't very encouraging. Amid more signs of a weakening economy and worsening corporate profits, three of the major stock indexes skidded to their lowest levels in five months last week. And many market pros expect stocks to continue falling until the economy shows some signs of recovering.

 

The Dow Jones Industrial Average tumbled 3.5%, led by Friday's huge drop. That left the blue-chip average up only 2.3% from its March 22 low and down nearly 11% so far this year.

 

The Nasdaq Composite Index plunged 6.5% for the week, leaving it up 3% from its April 4 low and down 32% for the year. The tech-heavy index is now down 67% from its record high in March 2000.

 

The broader Standard & Poor's 500-stock index fell 4.2% last week, leaving it at a three-year low. It's now down 29% from its high in March 2000.

 

Sparking a Sell-Off

 

What caused the sell-off? In part, it's worries that the weak economy may soon start putting a crimp on consumer spending, which has kept the US out of a recession so far.

 

That was fueled by Friday's report of a surprisingly big increase in unemployment last month, to 4.9% from 4.5%. There also was Thursday's survey from the National Association of Purchasing Management showing unexpected weakness in the services sector. 

[Hanging On]

 Those reports were very suggestive that the slowdown -- that had been largely contained in the business community -- is showing evidence of bleeding outward.  As a result, investors can't necessarily count on consumer spending to keep the economy afloat.

 

It is frustrating as an investor buying stocks. For the last year or so, the companies people were buying are in recession, and there has been disappointment that things haven't turned. But at least the consumer was still there.

 

Negative Into Positive

Even in nervous times like these, however, investors don't have to abandon stocks entirely. In fact, some pros think there are ways to use all the negatives to your advantage.

 

"Stick with what's been working," advises Peter Canelo, U.S. investment strategist for Morgan Stanley. The rising jobless rate makes it likely that the Federal Reserve will continue cutting interest rates. "So stick with interest-rate-sensitive and economically sensitive segments" that will benefit from falling rates, he says. These include banks, retailers and health-care stocks.

 

For investors fixated on owning technology stocks, Mr. Canelo says you should consider "old line" telephone companies. He also suggests the older semiconductor and enterprise-software areas, which he believes have good prospects of rebounding relatively soon.

 

All in all, say some market watchers, this may actually be a good time to conduct some old-fashioned research and look for stocks with cheap valuations and solid fundamentals. That way, you'll be in good shape once the market eventually recovers.

 

The question now, of course, is when that will be. Some think the recent sell-off, even if it continues for a while, may be the beginning of the market reaching a bottom.

 

"There seems to be a consensus on the Street that we're going to get some kind of a cataclysmic, washout type of a selloff," says Todd Clark, co-head of equity trading at W.R. Hambrecht, "and everyone says that will be the low." If that's the case, the worst may be nearly over.

 

Going Even Lower

But it's also possible that the major stock indexes will "continue to grind lower, which would be truly ugly," Mr. Clark says. Unfortunately, he adds, "I can't rule that second scenario out."

 

Some pros think the market's sharp slide in recent weeks is the beginning of what is known as "capitulation." That's when investors become so disgusted with stocks that everyone who wants to sell does, leaving the market nowhere to go but up.

 

"We're obviously getting closer to the bottom, and we're starting to see some capitulation in the marketplace," says Steve Massocca, president of Pacific Growth Equities. "This bear market is getting to be very long in age."

 

Reasons for Hope

There are other reasons to be optimistic. For one thing, this bear market is unlike previous ones in that inflation is low -- as are interest rates. So some experts believe the market could rebound as soon as there is evidence that corporate profits have merely stopped worsening, rather than are turning up.

 

"The real saving grace here for the equity investor is that it is a profit-driven bear market," says Mr. Paulsen.

Although the outlook for third-quarter profits isn't very promising, it may not be as bad as some fear. So far, 403 companies have issued negative profit warnings for the quarter, down from 433 at this point a year ago, according to Joseph Kalinowski, equity strategist at Thomson Financial/First Call.

Most of the warnings have been in technology, though there also have been some in retailing and even energy, which had held up well so far.

Whatever happens, there's certainly no shortage of advice about what investors should do.

"Be defensive," says Jeffrey Applegate, chief investment strategist for Lehman Brothers. Which means, "stay in the more defensive sectors: utilities, foods, banks, [or] cosmetics."

However, "if you think this is not something worse than a cyclical event," he adds, "then you should focus in on the stocks and sectors that typically do well when we finally see a rally." These include finance, industrial, consumer and even some technology stocks.

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