Investors struggle to see past panic

By Rodrigo Campos

NEW YORK (Reuters) - Wall Street hit the panic button last week and survived. But the shocks have left investors stranded.

Following its worst week in almost three years, the S&P 500 has fallen into correction territory and year-end forecasts are already being lowered. Safe havens like gold and the Swiss franc rallied.

Economic growth has slowed and budget-cutting legislation recently passed in the U.S. Congress could further dampen economic activity.

"In a word, volatility," Citigroup strategist Jamie Searle said.

The CBOE Volatility Index <.VIX>, the market's gauge of anxiety, had its largest daily percentage spike since early 2007 on Thursday.

Another source of worry was thrown into the mix late Friday, when Standard & Poor's stripped the United States of its top-notch "triple-A" credit rating. In its report, S&P sounded pessimistic that U.S. lawmakers could reach the consensus needed to rein in deficits that were responsible for this ratings cut.

"The long-term implications are daunting," said Jack Ablin, chief investment officer of Harris Private Bank in Chicago.

"Short-term, Treasuries remain a premier safe-haven refuge."

NO MAGIC FIX SEEN FROM THE FED

Until June, equity investors could count on the Federal Reserve to keep pumping money into the system, boosting equity and commodity prices. The $600 billion the Fed used to buy assets in a second round of quantitative easing -- known as QE2 -- flooded markets with cash and helped lower interest rates. That's over now.

Following a political showdown in Congress that took the United States to the brink of a default and a bitter battle to rein in spending, few expect more fiscal stimulus. And additional action from the Fed is unlikely after its meeting on Tuesday.

"There is certainly not going to be any fiscal stimulus coming, given the debt situation we are in," said Paul Mendelssohn, chief investment strategist of Windham Financial Services in Charlotte, Vermont.

"You've got so much discord and so much dysfunctionality in Washington that (Fed Chairman Ben) Bernanke has to think twice before he does anything."

Fears of another recession have crept back, fed by flagging economic growth and a perceived inability of politicians on both sides of the Atlantic to deal with escalating government debt.

In Europe, a credit crisis that initially hit Ireland, Greece and Portugal escalated and now threatens to engulf Italy, the euro zone's third-largest economy. Bond yields soared last week to highs not seen in more than a decade, worrying investors about Rome's ability to finance -- and balance -- its budget.

During the afternoon of New York's Friday session, Italy pledged to speed up austerity measures and social reforms in return for European Central Bank help with funding.

PANIC BEGETS PANIC

Having fallen in nine of the last 10 sessions, the S&P 500 closed the week down 7.2 percent -- its biggest percentage drop since the third week of November 2008.

Selling was broad as average daily volume for the week soared to 11.6 billion shares traded on the New York Stock Exchange, NYSE Amex and Nasdaq. That represents about a 55 percent jump from what was until last week the yearly average of nearly 7.5 billion.

Frantic moves in markets like the ones seen last week go beyond curbing investor confidence. Nervous consumers hold off on spending. Corporations don't sell their products and services so their earnings do not rise. Stock prices fall, creating a vicious cycle.

"We're facing years of markets that will be at times scary and chaotic and that won't be providing the kinds of returns people want to expect from investments," said Rob Arnott, chairman of Research Affiliates in Newport Beach, California, who oversees $80 billion in assets.

"Most people think double digits in the past was not difficult so, 'I'm going to be conservative and expect 7 to 8 percent.' But that's not what the markets are priced to give you -- it's more like 3 to 5 percent," Arnott said.

Following downgrades to U.S. gross domestic product estimates and weak global figures on factory and services sector activity, hopes for a boom in the second half of the year have evaporated.

"I just don't think 3 percent GDP growth in the second half is anywhere close to realistic at this point,' said Keith Davis, a bank analyst and principal at money manager Farr, Miller & Washington in Washington, D.C.

"The third quarter is starting off pretty slow, and people are bringing down their numbers."

On Friday, Credit Suisse equity strategists cut their year-end estimate for the S&P 500 by 7 percent to 1,350 from 1,450, with 1,400 as the target for year-end 2012.

Contrarian views are, nonetheless, ready to dismiss the panic and take it as a good time to jump back in.

"The biggest fear in our mind is: 'Is it a self-fulfilling prophecy? Is the market volatility causing people to really pull back?'" said Thomas Villalta, portfolio manager for Jones Villalta Asset Management in Austin, Texas.

"I think you'll see things kind of calm down over the weekend, and I suspect next week will be a better week for the market as people calm down and reassess the situation."

(Reporting by Rodrigo Campos; Additional reporting by David Gaffen, Jonathan Spicer, Chuck Mikolajczak and Caroline Valetkevitch; Editing by Kenneth Barry and Jan Paschal)