Under normal circumstances, investors could take some solace from the stock market's nice July 30 rally. But in light of the recent unpleasantness, the advance does little to alleviate growing investor anxiety -- or erase a significant part of last week's losses.

The stock market's July 30 advance was broad-based. The Dow Jones industrials climbed 93 points, or 0.7%, to 13,358. Standard & Poor's 500-stock index gained 1.0%, and the small-company Russell 2000 index jumped 0.8%. Last week, the S&P 500 slumped nearly 5%.

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What's next? No one can consistently foretell the short-term fluctuations of the market. What is a good bet, though, is that volatility will remain a constant over the next several months. In all likelihood, the market will continue to gyrate wildly because of conflicting currents running through the economy.

On the positive side of the ledger, employment is strong, corporate balance sheets are solid, profits are expanding, the economy is growing and stock valuations are reasonable, especially in relation to low interest rates. Exports are surging, thanks to a weak dollar and robust foreign economies, which will add to U.S. economic growth this year. In other words, Main Street is pretty healthy.

Wall Street is the problem. The negatives are, as Donald Rumsfeld might put it, some known knowns and some known unknowns. Housing and real estate markets are mired in recession. The subprime-mortgage market is a disaster, with rising loan delinquencies and home foreclosures and dramatic declines in the values of derivatives linked to subprime mortgages. And now we have a sudden (and ultimately healthy) repricing of the junk-bond market: The gap in yields between low-grade bonds and Treasuries has widened dramatically in recent weeks, to more-normal levels.

The known unknowns are more troubling. In the housing market, delinquencies in the so-called Alt-A market (a layer of borrower between subprime and prime debtor) are rising. Jeffrey Gundlach, the bond maven at TCW, also anticipates considerable distress among prime borrowers, whose adjustable rate mortgages will bring much higher monthly house payments over the next couple of years. He doesn't expect a surge in defaults, but he does think rising monthly mortgage payments will sap consumer spending, which accounts for 70% of the U.S. economy.

Shorter term, the more dangerous unknown is what a retrenchment in the leveraged buyout market will mean for stocks in general. Unquestionably, leveraged buyouts by private-equity firms have helped buoy the stock market over the past couple of years. But in recent weeks, financial markets have abruptly swung from easy, cheap financing of takeover deals to an environment in which low-cost money will be harder to come by. Now that the music has stopped, banks are left holding tens of billions of dollars of loans that they're unable to syndicate. The market is vulnerable to potential shocks such as banks writing down the value of the loans or reneging on commitments to extend loans, which could in turn cause high-profile deals to fall through. Another potential nightmare: leveraged hedge funds collapsing from suddenly volatile credit markets.

So how is one to approach stocks in this murky market? Quality, defensive domestic companies with good earnings visibility, such as Comcast (CMCSA, $27.21), CVS/Caremark (CVS, $35.12) and Walgreen (WAG, $44.83) should hold their value. Defensive stocks with large overseas exposure, including Johnson & Johnson (JNJ, $60.07) and Procter & Gamble (PG, $63.27), also look attractive. Tech, energy and infrastructure companies such as IBM (IBM, $114.52), Schlumberger (SLB, $95.35) and United Technologies (UTX, $73.63), which generate the bulk of revenues from overseas, should continue to flourish.

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