PANIC-STRICKEN BEARS

might be bailing out of the market like it's the Hindenburg, but long-term investors should probably resist the urge to jump. True, it feels like the financial world is a dirigible going down in flames, but committing the dreaded deed of selling into a falling market would almost certainly scorch a portfolio.

After Thursday's 387-point shellacking the Dow Jones Industrial Average dropped again Friday, ironically because the world's central banks tried to lubricate the credit markets with a healthy goosing of liquidity. Since Thursday the European Central Bank, the U.S. Federal Reserve and central banks in Asia, Canada and Australia have injected more than $260 billion into the global banking system, hoping that a cash laxative will loosen up credit markets constipated by the subprime crisis. But the extraordinary measures seem only to have served as a signal to the equity markets that things are really going quite horribly wrong.

"The European Central Bank's attempt to stabilize the market by injecting reserves has raised the question globally whether we're facing a liquidity crisis, which becomes sort of a self-fulfilling prophecy," says Michael Englund, chief economist at Action Economics, an independent research firm. "It's like the market's having a psychotic episode."

Banks concerned with liquidity hoard cash and fail to extend credit, the lifeblood of the economy. But the liquidity crisis is not likely to persist for very long. "There's a limit to how long these illiquidity crises can go on," Englund says. "In the past the Fed and other central banks provided reserves and as long as the banking system is healthy and the global banking system appears quite healthy they have a finite duration. But there's no way of guessing when the psychotic episode will end."

Those central bank moves mark the biggest injection of liquidity since 9/11, so perhaps the markets may be forgiven for jumping for their lives. The Chicago Board Options Exchange Volatility Index, or VIX, also known as the "investor fear gauge," has spiked by 32% since Wednesday's close, and there's little reason to think volatility will abate anytime soon.

Citigroup's proprietary cyclical expectations model, which often leads markets by one to three weeks, points to further volatility, according to Tobias Levkovich, chief U.S. equity strategist. In that context, he continues to recommend buying large caps, notably tech and big pharmaceuticals. Citigroup also recommends investors avoid areas that typically show poor returns in a more volatile environment, such as homebuilders, utilities and metals/mining stocks. What's most critical is that investors keep their wits about them. "It is important not to succumb to an emotional desire to sell before things get worse," Levkovich wrote in a Friday research report.

Peter Cardillo, chief market economist at Avalon Partners, agrees, saying investors have reached the point where they're selling without thinking. "There's a real fear here of 'Who's next?'" he says, referring to hedge funds freezing or imploding over their suddenly illiquid subprime holdings. "But I think it's overdone. There's enough strength in the global economy to continue modest growth here and abroad, so when it's all said and done it's not going to be a major catastrophe. For long-term investors it's probably a buying opportunity."

The re-pricing of risk is painful, casting an uncertain pall over corporate earnings, economic growth and private equity's ability to juice stock prices with premium takeouts, but ultimately it's a necessary evil. "People were becoming quite the financial cowboys through this cycle and credit spreads had narrowed to quite surprising lows," says Englund. "Correcting that process, though some describe it in negative terms, is actually desirable for the economy."

Of course it's tough not to hit the exits when the Dow's choked up more than 800 points since breaking the 14,000 barrier for the first time just three weeks ago. And it's fair to believe there are going to more hedge funds stumbling and blowing up as they're forced to mark-to-market their mortgage portfolios.

"But the risks are very dispersed, so in most cases it's probably irrational that most investors are unwilling to extend credit, particularly short-term credit," says Mark Zandi, chief economist at Moody's Economy.com. "But central banks are being aggressive and responding appropriately and creatively with funding, so I think that will stabilize markets. And if it doesn't, obviously central banks, particularly the Fed, will have to cut rates."

Whether a rate cut transpires or not is yet another unknown. Regardless, Zandi says that although equities in many part of the world look too pricey, it's hard to make a case that U.S. stocks are overvalued right now. "Take a step back and we're down 6% or 7%, which for most folks in the market isn't even labeled a correction. That's modest in the grand historical scheme of things."

Also bear in mind (no pun intended) that on the Street August can be the cruelest month, if only because so much of it is away on vacation. That only exacerbates the markets' wild swings.

With so much uncertainty and so many subprime landmines still waiting to be trod upon, it takes special fortitude to see the current environment as a buying opportunity. Only time will tell if it is. But underlying economic and banking-system strength, and central banks' moves to get credit moving again, make it almost certainly unwise to sell into the decline.