The past few weeks have seen a sharp decline in stock prices, across the board, despite strong performance by a number of reputable companies and sectors. But despite the sudden change in direction, investors should not panic. The recent pullback in the markets, so far, resembles what is known as a “correction.” Corrections, whether of an individual stock or, in this case, the entire market, are downward swings of 10-20%; they even occur in healthy bull markets. While there is always the possibility that such a correction may push a market already teetering on the precipice, over the edge, and bring an end to a bull run, in most cases they are temporary and short-lived. In fact, corrections are generally the result of reactions to overvaluations; they help reorient prices more closely inline with the perceived real value, and they can offer lucrative potential for opportunistic investors.
When the price of a stock, or market as a whole, has been climbing steadily, this growth can often outpace what value investors call "fundamentals" — numbers in a company’s financial reports that act as indicators of the company’s true value. When rapid appreciation of equities occurs, it can result in a fall in share price due to the fear of a bubble. Such pullbacks, meant to correct for overvaluation, often have little do with the actual performance of companies and markets; indeed, such corrections are more likely to occur in bull markets, as they keep growth from becoming too speculative.
While care must be taken to distinguish between a temporary correction and a permanent market downturn, the latter is often characterized by negative changes in actual performance, such as a contracting economy, or widespread failure to meet market expectations. But because mere corrections do not necessarily indicate under-performance, they actually present opportunities for savvy investors.
I must note that it is difficult for even experienced investors to predict exactly when a correction may occur. Ideally, if one could foresee market pullbacks, he would sell immediately before and then repurchase his assets at the new, lower price, once the correction has ended; this is difficult to master. Rather, investors — especially value investors, who focus on finding companies with strong fundamentals that the market has undervalued — should recognize corrections as an opportunity to make solid investments at reduced prices. If an asset was a sound investment before a correction (especially if the price reduction was due to a macro market event), it is an even better investment afterward. Moreover, corrections and pullbacks offer an excellent chance to reinvest dividends and profits.
The most important thing to remember during a pullback, or correction, is to not panic. While it is reasonable for investors to lock in profits and sell overvalued positions at the beginning, it is important to avoid overreacting and dumping sound investments due to minor market volatility. However, it is equally important to recognize the opportunities presented by such events, and take advantage of them for when markets begin to rebound.