The intense volatility of the stock market seems to parallel
the polarization of the good and bad news we are living with.

The good news is American companies are killing it. Corporate
cash flows are at record high levels. Profits are strong and operating expenses
are exceedingly well managed. Debt levels are under control as companies
continue to deleverage and interest rates are at historically low levels.

Holiday retail sales have been healthy and consumer
confidence is growing. Even the November payroll report showed surprising strength.
We may actually start to see the unemployment percentage dropping under nine
percent within a few quarters. All in all, it is quite evident that 28 months
into our recovery, the direction is absolutely positive. We can’t deny that
this recovery is slow and frustrating, and GDP expectations for 2012 are down
to 2 percent, but it is still a bona fide recovery.

Unfortunately, the bad news is really bad. The Euro zone is hanging
together with bubble gum. When the European Finance Ministers meet on Dec. 9,
they need to agree to move towards financial integration quickly. There is no
time for more talk. In exchange for emergency assistance, the weaker countries
will have to give up some degree of sovereignty. If an agreement can’t be
reached the Euro zone could absolutely collapse and the repercussions on our
side of the big pond would be inescapable. We are a planet that is much more
financially globally integrated than trade integrated. A deep European
recession and banking panic could derail our fragile recovery.

Call me crazy, but I can only imagine that over the next two
weeks the Euro zone leaders will agree to agree and put some meat on the bones
of long-term austerity talk and coordinated financial support. There is too
much at stake otherwise!

How should investors proceed through all of this drama? With
caution of course, but caution includes staying focused on both investment
fundamentals and investment time horizon. The fundamentals are good for
domestic multinational companies like Johnson and Johnson, Apple, Google, MMM,
Cisco, General Dynamics, and many many others. The fundamentals are good for
global international companies like Diageo, Novartis, Royal Dutch, and many
many others. Emerging markets are the engine of growth for the world and global
companies are prepared to expand and compete for growth.

When I look back over the years at the ebbs and flows of
intense volatility in the markets, I see that abnormally high volatility always
eventually reverts back to more reasonable levels and with it higher market
returns. I know there is a natural
urge to flee to the safety of cash, but that is what we call a “volatility
trap” and investor misery gets compounded by missing out on higher future
returns.

It’s easier to take this gut-wrenching volatility if you
have at least ten years before you have to start dipping into your investments
to live. For those who are “spending down” their investments I suggest keeping
very conservative asset allocations with at least 50 percent of your assets in
short and mid term high quality bond funds. Three excellent funds are the
Vanguard Intermediate-Term Admiral Index fund (VBILX), the Vanguard Intermediate-Term
Investment Grade fund (VFIDX), and the Vanguard Short-Term Investment Grade
fund (VFSTX). These three funds offer a good mix between treasury and corporate
bonds as well as a good mix between various maturity structures. Even though
you may be spending down your assets, stay at least 50 percent invested in
equities. Remember, stocks outperform bonds over time. Always have and likely
always will!

Those who have not yet started dipping into their
investments should be more aggressive and keep 60 percent to 80 percent
invested in stocks. There are many solid stocks with very healthy balance
sheets and excellent growth prospects. This time of excessive volatility and
fear, may well prove soon to be an opportune time in the stock market.