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Did a Stock Market Correction Just Start?

By Dan Caplinger - Jul 6, 2021 at 11:56AM

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The market showed signs of weakness coming out of the holiday weekend.

The stock market has soared to all-time highs in recent weeks, but Wall Street got off to a choppy start on Tuesday morning. As of 11:30 a.m. EDT, the Dow Jones Industrial Average (^DJI 1.27%) was down more than 400 points to 34,384. The S&P 500 (^GSPC 1.73%) had a somewhat smaller drop, falling 30 points to 4,323, although the Nasdaq Composite (^IXIC 2.09%) was down just 17 points to 14,622.

None of these declines were all that large. However, news from other parts of the financial markets seemed to highlight some of the risks that investors haven't necessarily paid very much attention to lately. Below, we'll go through some of the other things that stock investors need to keep in mind as they assess whether a stock market correction is dead ahead.

Person looking worried in front of laptop.

Image source: Getty Images.

A list of things to worry about

It would be easy to dismiss the day's declines as mere vagaries of the Dow except for one thing: Small-cap stocks were down even more. The Russell 2000 Index dropped close to 2% at its worst levels of the day. Small-cap stocks have done even better than their large-cap counterparts lately, and many see small caps as being more reflective of the health of the U.S. economy since smaller companies typically have less extensive global business networks than larger companies.

Other markets also weighed on sentiment. Crude oil prices fell more than $1.50 per barrel after climbing to nearly $77 for the first time since the mid-2010s. Oil-exporting countries failed to reach consensus on measures to continue to support the oil markets, and bickering among key members could threaten the production limits that have driven prices higher.

The bond market reacted to the perceived release of inflationary pressure from a potential decline in energy prices. Yields on the 10-year Treasury fell to 1.36%, their lowest mark since February. That sent banking stocks down sharply as well, as they had hoped that a steeper yield curve would mean more profits.

Thinking long-term

I don't have a crystal ball. So I can't say for sure whether this is the start of a true correction or just a tiny blip.

One thing I do know is that few people like to see the value of their portfolio go down. But in the long run, stock market corrections happen all the time, and they can be healthy parts of a bull market.

For long-term investors, corrections have a lot of benefits:

  • They often drive short-term traders out of the market, making stocks more affordable for those who continue to add money to their portfolios over time.
  • Often, all stocks fall largely in lockstep during corrections, even companies that aren't directly affected by whatever is causing the correction. Sometimes, even stocks that benefit from the factors causing a correction can go down, and that offers great bargains to opportunistic investors.
  • Corrections bring more pessimistic views of the future prospects for companies. That creates more room for those companies to exceed lowered expectations, and that often serves as a catalyst for future share price gains.

Perhaps most importantly, to the extent that corrections reflect real changes in economic expectations, they serve as valuable tools to measure how resilient a company is. Economic conditions rise and fall over time, and it's best for long-term investors to know whether companies will be vulnerable to adverse shifts.

Be ready for anything

There's no way to be certain whether a correction has started or whether today's move lower will be just another headfake on the market's way to all-time highs. Fortunately, long-term investors don't have to care. They can just count on owning high-quality stocks and letting them rise in value over the years.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
^DJI
$33,761.05 (1.27%) $424.38
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
^GSPC
$4,280.15 (1.73%) $72.88
NASDAQ Composite Index (Price Return) Stock Quote
NASDAQ Composite Index (Price Return)
^IXIC
$13,047.19 (2.09%) $267.27

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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