It is Official, It is Now a Correction

The DJIA, NASDAQ, and S&P 500 were both down on Monday. The DJIA and S&P 500 are both down more than 10% since their peaks in early October. That decline of 10% officially makes this decline a “correction”. Text in bold is my emphasis. From the WSJ:

Worries about the availability of credit and the potential for a U.S. recession hammered stocks and sent investors fleeing to super-safe Treasury issues, pushing major stock-market yardsticks into a full-blown correction for the first time in more than four years.

The Dow Jones Industrial Average slid 237.44 points, or 1.83%, to 12743.44. While up 2.2% this year, the blue-chip average is off 10% from its record set in early October. The Standard & Poor's 500-stock index fell 2.32%, or 33.48 points, to 1407.22, down 0.8% on the year and 10.1% from its October record.

A correction is traditionally defined as a 10% decline from a recent high. It is sometimes considered good for stocks if it removes speculative excess from a bull market and thus paves the way for a fresh round of gains.

But that sunny outcome hasn't been on the minds of everyday investors or Wall Street pros during the latest pullback. As credit woes continue to mount at major financial companies, fears are growing that market losses could continue and steepen, especially if consumers begin to feel the pinch from lower home prices, loan defaults and high fuel costs.

"There's a substantial risk of recession," said Lehman Brothers portfolio manager Aaron Gurwitz. "We've known that for some time now, so it's not surprising. That said, I don't think this is the time to be buying into" the stock market's weakness. . . . .

. . . . . Yesterday was the first time the Dow and S&P 500 have suffered a textbook correction since early 2003, when worries about a possible war in Iraq prompted heavy selling. That was the second-longest period without a correction for the closely watched indexes since 1900, according to Ned Davis Research. The longest span was 1990-1997.

Stock have fallen an average of 14% during corrections dating back to 1945, said S&P strategist Sam Stovall.

Mr. Stovall says he doesn't believe the U.S. economy is headed for a recession, although the stock market is clearly gearing up for such a scenario. "All the defensive sectors [like utilities and health care] are lining up in such a way to tell you that's what people are expecting," says Mr. Stovall.

Until recently, financial shares and consumer discretionary stocks were leading the declines. The pain now has spread to the broader market. Even the technology sector, which has been a highflier for much of 2007, has suffered. The tech-focused Nasdaq Composite Index fell 2.1% yesterday, or 55.61 points, to 2540.99, up 5.2% on the year but 11% off its late-October high.

Fears of banks cutting back on lending are "causing a big risk aversion" among investors lately, said David Andrews, executive vice president of research at bond powerhouse Pacific Investment Management. "Any contraction in credit raises concerns about higher defaults in the future and would hurt consumer spending, which in turn would hurt the prospects of companies," Mr. Andrews said.

The spreads, or difference between yields on Treasurys and other forms of debt have reached the highest level since 2003, as fears of accelerating credit problems have led investors to demand higher yields.

According to Standard & Poor's, which rates credit instruments, spreads on speculative-grade, or junk, bonds have widened by more than 1.8 percentage points since July, while spreads on investment-grade bonds have increased about 0.51 of a percentage point.

"In general, there is a tremendous flight to quality as liquidity in non-Treasury markets is very thin," said Bob Auwaerter, head of Vanguard Group's fixed-income group. Pointing to the widened spreads on such securities as corporate bonds and mortgage-backed securities, he said: "I view that as a buying opportunity for selective credit instruments such as high-grade corporate bonds and high-quality commercial mortgage-backed securities."