The merciless stock market correction continues. Repeated tariff threats from President Donald Trump have added to a sour, bearish mood among investors. Various U.S. trading partners have responded or threatened their own heavy tariffs, leading to declines in sectors like computer software and retail and a flight to perceived safe havens like gold and commodities.
But not all stock market corrections act the same way. "When it comes to a major correction, one thing I think is very useful are signs that there's extreme fear," David Saito-Chung, deputy markets editor at Investor's Business Daily and cohost of IBD Live, told the "Investing with IBD" podcast.
By looking for five key checkpoints, investors can gauge the severity of a correction and react appropriately. The checkpoints include determining the type of correction and watching for big revisions in earnings. What else to monitor? Watch interest rates and commodities. Understand investor psychology. And finally, keep a sharp eye on signs of a bottom.
Is The Stock Market Correction The Collapse Of A Bubble Or A Black Swan Event?
The first step for investors: Get your bearings by learning what type of market correction you're facing. Stock market corrections can be categorized into either the collapse of a bubble or the less-common black swan event.
Bubbles occur when outsize valuations collapse under their own weight. Valuations are not necessarily tethered to realistic revenues. They are often fueled by speculation from investors and rapid growth. Examples include the well-known dot-com boom of the late 1990s.
Black swan events that fuel market corrections are more complex. They are by definition unpredictable, with systemic consequences throughout the market. The Covid-19 pandemic upended entire economies through stay-at-home orders as governments raced to stop its spread and develop treatments.
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However, the 2008 financial crisis served as another black swan event, driven by greed and subprime mortgages sold by Wall Street firms, Saito-Chung says. "Very very few people spotted that, and even fewer people profited from that," he said.
While current market uncertainty centers on questions about how the government will look and operate after the Trump administration's deep cuts, it remains to be seen whether the current correction is a black swan event or a bubble. Heavy tariffs are not a new concept. The Smoot-Hawley Tariff Act in 1930 sought to apply protectionist policies to U.S. production. And while on the campaign trail, Trump made it clear his administration would use tariffs to achieve its objectives.
But the modern global economy is much more connected and complex than that of the 1930s, while a reshaping of the government could have unpredictable consequences.
Look For Declines Based Around Earnings
Watching key stocks and sectors can give investors an advance warning about the speed and severity of an incoming market correction. Companies must often plan capital and resource allocations far in advance, meaning that actions like major investments or pullbacks in production can serve as a useful early signal.
This is particularly true around consumer-facing retailers like Target, Walmart and even consumer electronics manufacturers like Apple. "The potential of an earnings shock has ramifications for the size of a correction," Saito-Chung said.
Watching Market Correction Indicators Through Commodities And Rates
Commodities like energy can be a great barometer for demand in the economy and for economic activity in general, since it's tied to every level of production. Oil itself is also used for final products like polyester clothing and plastics, showing another link between energy consumption and economic health.
An indication of a severe recession will be hinted at by a drop in crude oil demand, says Saito-Chung. "Keep an eye on oil because it's still useful to gauge the economy and gauge inflation," he said.
Gold's perceived safe-haven status among investors can also indicate whether investors are feeling flighty. Because gold is used to hedge against the market, it can help investors determine whether the market is moving to a risk-on or risk-off position.
Understanding Investor Psychology During Stock Market Corrections
How other traders react can be just as important as the catalysts behind a stock market correction, since frightened investors often make poor decisions. Saito-Chung says one way of checking market fear is through IBD's Market Trend page, which includes psychological indicators that signal changes in market direction.
"When we are near the bottom of a major correction, the percentage of bears surveyed by Investors Intelligence in its weekly surveys actually exceeds the level of bullishness," Saito-Chung said. He adds that the pattern has remained the same over the past 20 years.
As of March 13, the percentage of bears, at 34.50%, has crossed above the bulls at 27.60%, meaning a market bottom is more likely yet not absolute.
Spotting Signs Of A Bottom
By gaining confidence about where the market might bottom out, investors can be more aggressive when it matters: the beginning of a potential bull run, where the most profits can be made. But secondary indicators that show things like investor sentiment don't always yield a legitimate signal about a market correction.
Rather than watch investors, watch the market each and every day. A new catalyst for market growth can also start a new bullish cycle. The last period of growth, for instance, was caused by generative AI technology development as a key investing theme, Saito-Chung says. Its growth created new market leaders and ushered in the last bull cycle.
One key is to watch for actionable stocks that appear during a follow-through day. Follow-through days occur when an attempted rally sees a strong gain in volume versus the prior day, essentially confirming a market uptrend.
As always, managing risk is key in a bearish environment, even when a market bottom is clear. Conservative position sizing and stop-losses, as well as smaller pilot positions in stocks that seem to be working, are good strategies to help mitigate risk to your portfolio.
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