Should You Be Worried About the Upcoming Correction?

Like death and taxes, a correction from the market's feverish run-up may be inevitable.

Some of the previously most-feared stocks in the market, like Bank of America (NYSE:BAC), Citigroup (NYSE:C), Fannie Mae (NYSE:FNM), and Freddie Mac, have put up stellar gains from their March lows, but I hate to break it to you -- it ain't gonna go on forever.

I know, I know, you don't want to hear it and I sure don't want say it, but correction is almost surely lurking in the shadows of the huge recovery that the market has made since March. I can almost hear that haunting Jaws music, signaling that the question isn't "if," but "when" the market will peel back some of its gains.

A history of retreat
If we look back at historical examples of market recoveries, we can see just how surely correction seems to walk hand in hand with rebound. Here are examples from the two market crashes comparable to today:

Source: Yahoo! Finance. Dow index used for calculations.

Based on the magnitude of these past recoveries, we might be able to say that today's prices have more room to run, since the Dow hasn't even hit a 50% gain yet. But whether or not we see the market run further, it seems almost inevitable that a fairly sizable correction will slap the taste out of Mr. Market's mouth at some point.

When will it come? Past experience doesn't help us too much there since these big corrections came on very different schedules.

More important, though, is the question of how much we should fret about the coming correction. Here's a look at what the market did over the 10 years following the peaks of those post-meltdown rebounds:

Source: Yahoo! Finance. Dow index used for calculations.

While it's nice to see that the returns are positive, this little bit of data is hardly encouraging. What it says to me is that if you're invested at the peak of a post-crash rebound, the best you can hope for over the next decade are adequate returns.

Well that's great, so what do we do?
There are certainly advantages to investing in a broad index of stocks -- heck, even Warren Buffett recommends that for most individual investors. But I assume that if you're bothering to read this, you're looking for more than adequate returns.

If that's the case, don't bother with the market as a whole; your best bet is to get down and dirty and find the best individual stock opportunities out there. Sure, all individual stocks move with the market to some extent, but finding the best opportunities can mean capturing significantly better performance than the rest of the market.

For instance, it's been very well publicized that the overall S&P index has been a pretty lousy performer over the past decade (for the record, it's down 25%). However, there are quite a number of stocks that have gone gangbusters over the past decade. Check out these multibaggers:

Source: Capital IQ, a division of Standard and Poor's.

That was then ...
The standout performers of the next 10 years may not be the same as the last 10 years, so it's up to us to figure out where today's best opportunities are. A group of my fellow Fools recently weighed in with their thoughts on the best sectors for today's market and they see opportunity in sectors such as consumer staples, health care, and some select retail and consumer discretionary.

With my own stock picking, I'm sticking to the tried and true methods of finding the best bets. That is, looking for great companies that are able to churn out high returns on their capital and are trading at attractive valuations. Sure, you can get more complicated than that, but why bother with vector calculus when simple addition will do?

Be sure to also check out:

• The Top 10 Recession Stocks
• A take on the return of optimism.
• Why you should pray for inflation.
• My look at why four stocks are exploding.