First, take control

There's no denying that this is a difficult environment. Volatility is on the rise, which makes trading a harrowing task for even the most grizzled veteran. But correlations are also on the rise, which means that different assets -- precious metals, stocks, corporate bonds, commodities, crude oil -- are increasingly rising and falling together.

So not only does the market feel more dangerous, it's harder for investors to diversify, relying on a wide variety of investments to smooth out the ups and down in their portfolios.

Correlation of crude oil to S&P 100 Large Cap Index © MSN Money

The chart above shows how crude oil futures and the S&P 100 Large Cap Index have been moving in lockstep over the past three years. Before, they moved to their own drumbeat. (The way the chart works, the higher the correlation number, the more oil and stocks are moving together.) When that happens, there is no diversification benefit to be had by holding both in a portfolio. The team at Credit Suisse notes that it's the same story with U.S. stocks versus foreign equities and stocks versus commodities.

This combination of unpredictable political risk, increased volatility and tighter correlations across asset classes is a toxic one.

We have a situation with two possible outcomes: We default and get a downgrade (and everything falls apart) or we get the budget under control and raise the debt ceiling (and the specter of default passes, with stocks and other risky assets blasting higher). There really isn't a middle ground. And with all those assets moving together, you can't hedge your bets.

SLV – iShares Silver Trust ©

A great example of this can be seen in the way silver imploded in May, after the U.S. dollar spiked after the killing of Osama bin Laden. Suddenly, it felt like America had gotten its mojo back. Global financial markets responded by sending the dollar higher, ending a four-month downtrend.

For most of us, it was all good. Bin Laden was dead. We felt a surge of pride and patriotism. Gas prices dropped. And inflationary pressures cooled, thanks to a stronger dollar.

But because the dollar has a close relationship with risky assets, Wall Street panicked. Silver and gold fell first -- followed by crude oil and a long list of other commodities, including industrial metals and copper. Then foreign stocks. U.S. equities came under pressure in June. And finally, corporate bonds suffered a dramatic sell-off on June 16 that marked the end of the drop.

So you can see, there was no place to hide. The selling pressure unleashed by currency fluctuations spread through the system like wildfire. Diversified or not, people got burned.

No more buy and pray

My point is this: The investing environment has changed. Decades ago, when correlations were lower and diversification more powerful, buying and holding a range of investments was the way to go. It paid off over time. And this is still how a lot of people run their retirement investments -- buy and hold, or even buy and forget.

But the advent of a more integrated global financial system has reduced the protection offered by owning bonds and dabbling in commodities along with owning stocks. Just when people need protection, it's harder to find in the traditional places.

The intriguing news is that while correlations are on the rise among asset classes, we're seeing a drop in correlations within the stock market. Simply put, certain areas of the market still outperform other areas on a regular basis. As a result, investors can diversify by regularly moving into areas of the market showing strength and leaving those showing weakness.

In other words, investors need to refocus on good old-fashioned stock selection -- especially in an environment of extreme political and economic uncertainty.

That's because it offers the best result no matter what Washington does on the debt ceiling: If Obama and the Republicans do the right thing, the strong stocks will lead the way; if they don't, strong stocks will fall the least and give you time to get out.