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Stocks Slide Again: Prepare For More Volatility…Not Armageddon, Koesterich Says

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Stocks rose early Thursday after some better-than-expected earnings from Bank of America, Morgan Stanley and eBay, and a successful Spanish bond offering. But the gains faded as the morning brought another round of weaker-than-expected U.S. data and European markets went south.

Selling accelerated in the early afternoon before major averages recouped some losses. At day's end, the Dow was down 0.5% to 12,963 after having traded as high as 13,080 and as low as 12,897. The S&P 500 fell 0.6% and the Nasdaq slid 0.8% amid renewed weakness in Apple.

Thursday was a good microcosm for the year to date, where the market started off strong but has since hit a rough patch.

Expect continued volatility in the weeks and months ahead, says Russ Koesterich, Global Chief Investment Strategist at iShares, a unit of BlackRock, which is the world's largest asset manager with about $3.5 trillion of assets.

"The liquidity-driven part of the rally is starting to peter out," Koesterich says. "What we have going forward...is more of an economic-and earnings driven market, which unfortunately won't be quite as much fun and it won't be as smooth either."

That said, Koesterich thinks the bears are wrong about the rally being over. "The market can move higher in the future," he says, arguing valuations remain "reasonable," inflationary pressures are "well contained" and the global economy is "stabilizing" -- despite some hiccups of late.

Room to Move

Unlike central banks in the U.S., Europe and Japan, emerging market central banks still have "room to move," he says, citing rate cuts this week from the central banks of India and Brazil. Such actions should insure a "soft landing" in emerging markets, notably China, he says, and help put a floor under financial markets.

In the intermediate-term, Koesterich says investors should "prepare for more volatility" but not Armageddon.

Arguing that U.S. income stocks have become too expensive, he recommends international dividend plays via the iShares Dow Jones International Select Dividend Index Fund (IDV) and the iShares Emerging Markets Dividend Index Fund (DVYE).

In addition, he recommends the iShares iBoxx Investment Grade Corporate Bond Fund (LQD). Investment grade bonds look attractive relative to high yield debt "and should hold up better during a more volatile quarter," according to Koesterich.

Looking a little further out, the strategist says the Fed is likely to stand pat, at least until 'Operation Twist' runs its course at the end of June. Beyond that, his biggest concern is the looming "fiscal drag" that's set to arrive Dec. 31. If Congress doesn't act to prevent the expiration of various temporary tax cuts and the scheduled spending cuts owing to the failure of the Super Committee last year, the U.S. economy could suffer a hit equal to 3%-5% of GDP -- enough to tip a fragile economy back into recession.

Koesterich doesn't expect the market to start focusing on this issue in earnest until the fall and, besides, it seems like there's plenty of other stuff for traders to worry about right now.

Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com

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