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What's an investor's best bet? Ride out the volatility

Welcome to the new era.

Investors have been waiting two very long days to see how stock, currency and bond markets react now that the United States has lost its top-notch triple-A credit rating.

No one is ruling out a continuation of last week's turbulence, which saw major stock market indexes suffer their worst losses in years. But there are good reasons to believe that the market's anxieties will remain centred on the health of the global economy, rather than the downgrade itself.

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What to do? As painful as it is for investors to watch their investments shrink in value, broad selloffs are not usually the best time to panic, dump all their equities or do major surgery on their portfolios. Those who bail out on their financial strategies in moments of stress are acting on emotional impulses, which rarely got anyone to a healthy retirement.

Even the 2008 and 2009 downturn demonstrated this. Those who sold in the midst of the nasty market crash had to make another, more difficult decision on when to return to the market and buy again. Those who rode out the volatility, though, came through with only minor scrapes.

Of course, the declines of 2008 and 2009 left scars. Investors are now suspicious at the first sign of trouble. No wonder: That event sent the S&P 500, a key measure of the U.S. stock market, down more than 50 per cent to 12-year lows. Banks disappeared overnight and dividends shrivelled up.

While no one is minimizing the significance of the U.S. credit rating downgrade at the hands of Standard & Poor's on Friday evening, it did not mark the same sort of economic rupture.

Peter Drake, vice-president of retirement and economic research at Fidelity Investments Canada, noted that the 2008 downturn involved a lot of uncertainty, particularly about the solvency of major global financial institutions.

"Now, we know what the issues are," he said, and investors should see the downgrade as "one step toward a long and tumultuous road to solving them."

Indeed, the downgrade itself wasn't the biggest shock to markets. Standard & Poor's had warned in July that it saw a 50-50 chance of cutting the U.S. credit rating.

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Some observers have even cast doubts on whether Standard & Poor's has the credibility to make a call on sovereign credit worthiness after it botched ratings on the sort of mortgage-related securities that triggered the 2008 financial crisis.

These doubters aren't cranks, either. Nobel-Prize-winning economist Paul Krugman tore a strip off Standard & Poor's in his New York Times blog, saying: "It's hard to think of anyone less qualified to pass judgment on America than the rating agencies."

He also cast aspersions on the accuracy of their number-crunching, calling it "amateur hour."

Still, the downgrade has arrived and markets must deal with it. On the upside, Standard & Poor's made it clear that it sees no problem with America's ability or willingness to meet its financial obligations, which should alleviate concerns that this marks the start of a financial catastrophe.

Mohamed El-Erian, chief executive of Pacific Investment Management Co., which is the world's largest bond investor, even saw a silver lining in the downgrade: Perhaps U.S. policy makers will put bickering aside and unify around a common purpose – "putting the country back on the path of high growth, job creation and financial soundness."

Markets were already on edge last week before the downgrade, suggesting that investors were mulling over factors that have more bearing on their investments – like the spread of the European debt crisis to Italy and Spain, and the rising likelihood that the U.S. will slip back into recession amid a spell of weak economic reports and cutbacks in government spending.

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The downturn fell in line with previous bouts of volatility, which saw investors flee economically sensitive assets (like stocks and commodities) to safe assets, such as U.S. Treasury bonds and the U.S. dollar.

If the volatility resumes, this next round might not be much different.

"The Treasury market will still be seen as a safe haven," said Sherry Cooper, chief economist at Bank of Montreal. "There is no other market with its depth and liquidity."

Indeed, she sees the downgrade issue as a "sideshow" to the main event in Europe.

While that might not be good news to investors who don't like wild rides, it should at least give them some comfort: The new era might not be much different from the old one.

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