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:

Date of Bottom

Length of Rebound

Size of Rebound

Size of Correction

July 8, 1932

Two months

94%

(37%)

Oct. 4, 1974

23.5 months

74%

(27%)

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:

Date of Rebound Peak

Returns Over Next 10 Years

Annualized 10-Year Performance

Sept. 7, 1932

35%

3%

Sept. 21, 1976

77%

6%

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:

Company

10-Year Price Change

Apple (Nasdaq: AAPL  )

978%

Chesapeake Energy (NYSE: CHK  )

646%

Starbucks (Nasdaq: SBUX  )

256%

Freeport-McMoRan

252%

Goldman Sachs (NYSE: GS  )

165%

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:

Apple and Starbucks are Motley Fool Stock Advisor recommendations. Chesapeake Energy and Starbucks are Motley Fool Inside Value selections. The Fool owns shares of Chesapeake Energy and Starbucks. Try any of our Foolish newsletters today, free for 30 days

Fool contributor Matt Koppenheffer owns shares of Bank of America, but does not own shares of any of the other companies mentioned in this article. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool. The Fool's disclosure policy has never once been caught with its pants down. Of course, it doesn't actually wear pants ...


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Comments from our Foolish Readers

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  • Report this Comment On August 27, 2009, at 11:31 AM, jason2713 wrote:

    No because the gov't/wall street/and the banks are going to prop it up.

    The only way it will correct significantly is if people see their money isn't going into sound investments and start pulling their money out (like today). Wake up people, you're being dooped.

  • Report this Comment On August 27, 2009, at 12:02 PM, MaBellIsDead wrote:

    The sure path to a "correction" is for people such as yourself to declare doom and gloom is right around the corner. What is your motive?

    You guys are scaring people into selling, and that's no "correction." Even the term "correction" implies there is an unknown force at work in the Market, which is pure superstition.

    Bottom line: Hedge fund managers and other big guys are trying to knock the market down so they can buy more cheap stocks. Who else has a better motive and resources?

    "Investors" won't fall into that trap.

  • Report this Comment On August 27, 2009, at 12:33 PM, matthewbanis wrote:

    Actually,

    "The Great Depression's post-crash rally

    For some perspective, take a look at the situation right after the 1929 stock market crash:

    From early September 1929 to mid-November, the Dow lost almost 50% of its value.

    Then, though, the market rebounded over the next five months until mid-April 1930, as the Dow jumped over 50% and recovered more than half of its previous losses.

    Only then did the worst of the fall begin, as the Dow plunged an astounding 85% before bottoming in 1932.

    Now compare that to the situation we've faced lately:

    From late 2007 to March 2009, the S&P lost about 58% of its value.

    Since the March lows, though, the market has rebounded, and the S&P has jumped 47% and recovered about a third of its losses.

    So what comes next? If you believe that the Great Depression serves as a reasonable model for what's going on today, then two things pop out. First, the 1930 sucker's rally lasted about five months -- only a few weeks longer than the current rally has run.

    Second, the current rally has roughly matched the Dow's 50% bounce in 1930, although for the S&P to recover half of its losses since late 2007, it would have to jump to around 1,120, about 15% higher than its current level.

    Of course, there are plenty of other models that would lead you to different conclusions. After the 1987 crash, for instance, stocks recovered quickly and kept on moving to new highs in relatively short order. During the 1970s, on the other hand, a substantial recovery for stocks hit a ceiling, and markets traded roughly sideways for much of the rest of the decade."

    Of course, the Government is fixing the problem with what originally caused the problem, i.e. issuing more debt, let's see how long that works for.

    Three words: Sell, Sell, Sell.

    Kind Regards.

  • Report this Comment On August 27, 2009, at 12:56 PM, plange01 wrote:

    this has been the biggest false rally since the last depression!with real unemployment over 20% 1,850,000 forclosures so far this year.rising oil,inflation and bankruptcys there is no good news at all just a lot of storys with wishful thinking!.the US is now in its 9th month of a depression that will most likely last the next 3-5 years and get far worse....

  • Report this Comment On August 27, 2009, at 1:10 PM, ozzfan1317 wrote:

    Not saying its all sunshine and rainbows but I say we might drop another 5% and then I see us Hitting Dow 11,000 by years end.

  • Report this Comment On August 27, 2009, at 1:20 PM, wuff3t wrote:

    @plange01 - never mind, at least we'll have you to cheer us up!

    My feeling is that if we see any sort of major dip it will be followed by another surge - my guess is there are a lot of people sitting on the sidelines with cash, wishing they'd had the nerve to buy at S&P 666, and will have more courage next time there's a downturn. However I'm not sure how long their courage will endure if the economic news continues to be gloomy after that. If there's a dip then I think it could be a very big one.

    Just my worthless five cents...

  • Report this Comment On August 27, 2009, at 2:48 PM, strongsafety wrote:

    I ,too, am long an excessive amount of BAC and have little cofidence in a move past 21 in the next couple of years.Since they do not pay a dividend worth noting, I get paid nothing for my exposure to this highly leveraged, recklessly managed behemouth.Only the greater fool theory of investing would induce me to acquire any more of this "investment".I have been burned by my own lack of focus and imprudence after holding this inherited(by takeover) business acquisition addict. Fool me once...

  • Report this Comment On August 27, 2009, at 5:22 PM, jesse2159 wrote:

    My father never graduated from elementary school, never had a job above ditch digger and read only haltingly or the comics, yet, when he died in 1987 he was very close to being a millionaire. How? He started buying stocks in 1930, often one at a time. The first stock he purchased was his employer, Consolidated Edison in New York City. Over the years he bought Coke, and Union Carbide and some time later IBM and Xerox. You don't have to be well educated to understand that good companies are a good place to put your money. There will always be corrections,..ignore them.

  • Report this Comment On August 27, 2009, at 5:26 PM, bernbern0 wrote:

    As usual truthisntstupid isn't stupid! With solid dividend paying stocks, I too hope all of you doom and gloomers keep predicting "corrections" causing folks to sell.. And along with truthisntstupid and other dividend investors I keep making money whether stocks go down or up.

  • Report this Comment On August 27, 2009, at 5:26 PM, AuditorFool wrote:

    -Government Debt is in the solar system

    -Unemployment is double digit with real unemployment near 20%

    -Foreclosures everywhere

    Government controlled healthcare around the bend.

    It ain't looking good folks.

  • Report this Comment On August 27, 2009, at 5:43 PM, stonebusted wrote:

    Until we get a government that works by a modern constitution each day is a thing of luck.

    This country is controlled by the greedy and self servers.

    I don't see how we even make it short term. Sooner or later when you are living on luck the coin comes up on the wrong side.

  • Report this Comment On August 27, 2009, at 6:08 PM, dbbfool63 wrote:

    I sure do not see anything rosy about our economy, all the government is doing is borrowing and printing more money.

    How many new jobs have been created? Maybe a few at the junk yard for forklift drivers to crush the clunkers and at what cost to the Tax Payer.

    The only thing I have heard of that people are spending money on is Guns & Ammo.

    I say put your money in the 2 guys who have made the products that made America what it use to be.

    Smith & Wesson

  • Report this Comment On August 27, 2009, at 6:47 PM, TxTom wrote:

    Everyone said there would be "doom and gloom" in today's market... at least a 5% correction. It didn't happen. And even if a WHOLE 5% dip is in store, what difference does it make? For those who bought into bank stocks (C, BAC, FITB, STT, etc) when they were beaten up entirely, does a 5% correction really hurt after 400%+ gains? I don't think so.

    I stubbornly held onto C even through today, and what happened? John Paulson was buying up Citi like crazy, and the stock jumped again today. Now it qualifies for more margin trading. $6 to $7 by year end, maybe more.

    Put in stops if you are worried. Buy HBAN before it follows C and BAC. Take a serious look at SIRI. Don't overlook SQNM - one positive press release away from $20+ per share. And for those who like DRYS... a nice day indeed, with more to come.

    All those naysayers who think they should be on the sidelines waiting... good luck. Today's traders have never seen what can happen coming out of a very scary fisaco/recession. So they keep saying "watch out". Okay, I'll watch out while the $$$$$$ keep ringing up.

    Only in America.

    Happy trading!!!

  • Report this Comment On August 27, 2009, at 7:35 PM, stan8331 wrote:

    The obvious question for all these anayses that show how badly you could have done if you bought at the top of a previous business cycle, then held and never bought any more, is WHY? Why on earth would you buy when valuations are high, but refuse to buy when they drop precipitously? Nobody can expect good returns if they insist on investing in the worst manner possible.

    Going 100% in equities never makes sense to me, in any market under any circumstances. What does make sense is to always participate in the market, but also always keep significant cash on hand for new buying opportunities (and of course there should also always be a NON-investment reserve fund). I'm always searching for ways to decrease my investing degree-of-difficulty, not increase it. Attempting to precisely call market movements isn't a game I wish to attempt to play.

  • Report this Comment On August 27, 2009, at 10:50 PM, TxTom wrote:

    When the bottom came in March and everyone was still running for the exits, I put 99.9% of my available resources into ridiculously low-priced stocks (mostly major banks) even though I was trained to "never put all eggs in one basket" (University of Texas School of Business). However, logic prevailed over training. Returns have averaged 450% since then. I refuse to give it back.

    A person can't always be conservative when conditons and common sense say otherwise. Everyone has their own individual risk tolerance. You know your level. If you are worried, nervous, and can't sleep - don't do it.

    There are still a lot of bargains available. Choose carefully, for good reasons, and anticipate which sectors will reward you six months from now. Know why you believe in the stocks you purchase, or don't buy them. Put the appropriate stops and hedges in place. It isn't rocket science.

    Happy investing!!!

  • Report this Comment On August 28, 2009, at 6:56 AM, CarryOnAgain wrote:

    I too went long Citigroup in March, but only in a small way. However, this means I don't have any fear about giving back profits so I'm inclined to let it ride for a few years.

    Corrections always occur - it's not a question of if but when. Yet this is simply saying the blindingly obvious. A rally begins when a few brave souls recognise bargains, and others join in. At first this is pooh-poohed by the mainstream as a "Deat cat bounce". But eventually it reaches the point of capitulation - when the vast majority concede they were wrong and fear of missing out of the next bull market drives the rally further. It is ONLY when everyone is in, when everyone is bullish that a major correction can happen, simply because there is nobody left to buy. What is the catalyst for a correction? It will be data related, probably evidence of a double dip recession, maybe house prices dipping. Who knows.

    We should also not put too much emphasis in what happened in 1930. In the 1930's people were completely broke - not two cents to rub together. That's why the economy imploded. Please remember that today, even the poorest Americans (and other developed nations) have money to spend. Just a thought.

  • Report this Comment On August 28, 2009, at 9:06 AM, howboutme wrote:

    Actually,

    The best time to go fishing is when the atmosphere goes from a high pressure system to a low pressure system rather quickly. As in the case of a thunderstorm, Feeding is most aggressive right before the rain hits and stops cold when the raindrops start hitting the water. Thats the best fishing.......just as playing the market, buying at the bottom and riding to the top blows away any gains you will see long term..... timing is everything. If you missed the last 400% gainers, you'll be lucky to see 25% over the next couple years.

  • Report this Comment On August 28, 2009, at 12:02 PM, PsycheDaddy wrote:

    I would suspect that an economy that had so many things wrong with it now and a government that is anti-coporation, that the stock market would reflect a poor outlook for the future. That's why I don't believe that wall street and the markets are reflecting the true economic conditions that we face. When I see stability in the economy and government, no matter at what level the DOW is at, I will invest then. Right now, I will watch, hold onto my cash and see where the safest move is. Right now it might be looking to move to another country. lol

  • Report this Comment On August 28, 2009, at 12:07 PM, jason2713 wrote:

    My father is a wealthy man, and moved his money out of the country long ago. He put it into the canadian dollar because they have no debt, unlike the US and he foresaw this coming (devaluation of the dollar).

    He put it in when the canadian dollar was around $.70C to $1USD. As you might suspect, he's raking in the benefits of the move. Smart man.

  • Report this Comment On August 28, 2009, at 4:39 PM, adutt1 wrote:

    This article is good as a cautionary note. However the author delves only in past--way to past. He completely ignores the today's reality, namely, global upcoming industrial powers, like BRIC countries.

    Sure there will be correction on our market (USA), I personally believe it will be of the order of 20% - 30%, starting around 09/15 or 10/01/09 and will last no more than 3-weeks. I have made fair investments in C, BAC, & F. I am going to put stop loss, however I do not believe this correctio will scratch F at all. Go foreign to protect your gains now, and ingore this article and the author.

  • Report this Comment On August 29, 2009, at 11:04 AM, Gorm wrote:

    Markets prosper on promising expectations, reasonable valuations and strong earnings potential.

    1) Today the market is overvalued.

    2) Q2 earnings were mostly savings, not earnings and margin growth.

    3) The negatives haunting us are horrendous:

    a) Real estate valuations falling. 32% of mortgaged residences underwater with forecast to increase to 48% in 2011. For most Americans home equity constitutes their greatest sense of wealth and well-being.

    b) Banks are facing tough times and they know it. They are fearful of eroding capital. Banks have swung to the other end of the spectrum, lending to the most pristine of borrowers and then under conservative advances. Toxic assets and derivatives are still out there. They were NOT vaporized!! No recovery is possible without a willing and able banking system as Americans are borrowers, not savers.

    c) Consumer segment is accountable for up to 70% of GDP. Many are scared shitless (fear of job loss or hours reduction, negative home equity, hurting 401(k), overleveraged, massive publicized negatives, rethinking the hazards of immediate gratification, etc.

    Excluding a few dozen other negatives, all is rosy!!

  • Report this Comment On August 29, 2009, at 11:25 PM, ibropin wrote:

    as usual this thing is just like the stocks I always pick about 50 50 with no clear direction

  • Report this Comment On September 04, 2009, at 4:07 PM, TxTom wrote:

    Yeah, yeah... correction correction. I keep hearing that, and my portfolio keeps increasing.

    If by "correction" you mean the market will pull back a bit, then fine. That will always happen. But overall the direction is "up", and that's what counts.

    This is the single best investing opportunity you folks will EVER have during your lifetimes. Either get in, or sit on the sidelines and gripe.

  • Report this Comment On September 04, 2009, at 7:40 PM, keninden wrote:

    I think it would be awful if the market inched up, decade after decade, in a straight line. Try replacing the word "correction" with "sale". I have been investing since 1980, making mistakes before finally turning into a Fool. (Later, I discovered Motley Fool.) Except for being pretty alarmed in November when credit froze, I'm almost ashamed of my greed over the last year, and it has paid off. Since I'm not retired and still put new money into investments, I would prefer a dip before, say, 2012 rather than getting to whatever value that will be in a straight line.

  • Report this Comment On September 04, 2009, at 8:15 PM, unclewilty wrote:

    No news is good news.

    Good news is good news.

    Bad news is good news.

    Let's see what we have here:

    No easy credit + fewer home loans+ less equity,+less new construction,+declining mfg+ less auto sales+ less purchasing power+ companies cost cutting to the marrow+employee raises frozen+ disgruntled workforce+ highest unemployment in years and rising+the dollar getting weaker by thy minute+China competing for needed resources and commodities+government debt that would make ur head spin=

    The formula for a raging sustained bull market.

    Welcome to the nightly edition of: "We have all been transported in our sleep to a planet in a parallel universe called "backwards world",or

    "I thought Ponzi schemes were outlawed years ago."

  • Report this Comment On September 04, 2009, at 8:20 PM, jaelkim wrote:

    Honestly I think a correction will have little affect on the good companies. I also think once the correction happens the market will quickly rebound due to investors buying some of these stocks at value prices. However I do think it will have a big impact on overbought stocks and apparently there are a lot of them out there. I'll have to re-evaluate my positions and see if I'm holding any overbought stocks and maybe cash on those. Who knows, I might be able to get back into them at even better prices or find even better deals on other stocks.

  • Report this Comment On September 05, 2009, at 10:52 PM, djdd11 wrote:

    Does anyone think that this may coincide with the following that another advisor was trying to highlight about the Option ARMs that is affecting the economy?. He quoted below:

    * The Wall Street Journal says, "Option ARMs' worst troubles may yet lie ahead... since the bulk are due to reset over the next three years or even earlier."

    * The Boston Globe predicts, "There could also be a whiplash caused by the big white elephant in the middle of the room - option ARMs... a lot of them are going to be seriously upside down, probably at least 40 percent upside down."

    * And according to Goldman Sachs, nearly half of all outstanding option adjustable rate mortgages - more than $375 billion worth - will eventually default!

    I wonder how much truth is there in this facts?

  • Report this Comment On September 07, 2009, at 8:43 PM, colddrink73 wrote:

    Look here is the truth.

    If things get really bad shorting wont work because everything will fail. The money you just made wont buy you a glass of water.

    If you think it is going to get that bad buy some land in Colorado and build a bomb shelter and stock up on canned goods and water. Get some guns and ammo and hold on.

    If the correction comes who cares.... put some stops in place now and then get back in some stocks you got stopped out of a few months later. I'd look at Blue Chips with high dividned.

    Untill then pay off your debt, save up an emergency fund and....if you can put money in stocks do it.

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