If this is a stock market ‘correction,’ it’s still early

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Bad as the stock market pullback may feel, Wall Street isn’t even in garden-variety “correction” territory.

Not yet, anyway.

The Dow Jones industrial average slumped 242 points, or 2%, to 11,613 on Wednesday as world markets were battered again by fears that Japan’s nuclear crisis could worsen.

The Dow (charted below) now has fallen 6.3% from its 32-month high of 12,391 on Feb. 18.

The sell-off could get significantly worse and still be considered a normal correction -- meaning a temporary setback in an ongoing bull market.

A correction generally is considered a drop of 10% to 20% in key indexes from their recent highs. That’s what the market suffered last spring, when the European debt crisis and a slowing U.S. economy triggered a painful pullback in stocks.

The Dow fell 13.6% from April 26 to July 2 before resuming its climb.

Broader market indexes fell more sharply in that setback. The Standard & Poor’s 500 index dropped 16% before it bottomed. The Russell 2,000 small stock index fell 20.5%.

A drop of more than 20% typically is considered a new bear market, but the Russell index only crossed that line for a day before turning higher. The bear had no time to sink its teeth in.

This time around broader U.S. indexes are down in line with the Dow from the market’s Feb. 18 high: The S&P 500 is off 6.4%, the Russell index is down 6.3% and the Nasdaq composite (charted at right) is off 7.7%.

Things already are worse in parts of Europe: The German market is down 12.3% since Feb. 18; French stocks are off 11.1%.

The problem with speculating about corrections is that it sounds neat and clean. Yet you don’t know whether a correction will give way to a full-fledged bear market until after the fact. (By definition, every bear market has to begin with a correction.)

What needs to happen for a market decline to stay within the 20% correction boundary is that enough investors must believe that 1) a relatively modest sell-off makes bargains out of many stocks and that 2) the fundamentals justify higher share prices sooner than later.

That, in turn, requires faith that the economy and corporate earnings will continue to grow.

The market’s modest slide so far indicates that most investors haven’t given up that faith.

But given the hefty gains stocks have racked up since August, that also means there’s a lot more room for doubt to creep in if the Japanese crisis deepens or if oil prices surge again because of social unrest in the Middle East and North Africa.

-- Tom Petruno

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