Stocks & Markets February 7, 2010, 7:29PM EST

Stocks: How Investors Might Play the Pullback

The downdraft in equities may present global buying opportunities. Some investing pros tell Bloomberg BusinessWeek what they favor

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With stock markets quaking around the world, commodities prices tumbling, and trouble in Europe's sovereign debt markets spreading fear of contagion, it's fair to wonder if a new bear market is in the offing. After careful thought and deep breathing, however, investors are more likely to remember that corrections are an inevitable part of market activity. After a 72% rally that spanned more than 10 months, U.S. stocks were long overdue for a pullback.

The Standard & Poor's 500-stock index peaked on Jan. 19, closing at 1,150.23. In 13 subsequent trading days, it fell 7.3% to finish at 1,066.18 on Feb. 5. The Dow Jones industrial average, after breaking below the 10,000 level on Feb. 4 and Feb. 5, bounced back to close at 10,012.23 on Feb. 5, down 7.1% from the end-of-day top of 10,725.43 it registered on Jan. 19.

For investors who sat out the 2009 rally and have been bemoaning that they missed what some called once-in-a-lifetime bargains, the sharp pullback should be a welcome buying opportunity. How many people view it that way?

"[The U.S. stock] market has averaged a 10% correction once a year for 100 years. Is it realistic to believe we could [avoid] a 10% correction after the run-up we've had?" asks Alan Skrainka, chief market strategist at Edward Jones in St. Louis. "People need to stay calm, stay invested, and stay focused on their long-term goals."

Fears that Greece and Spain might default on their debt garnered most of the attention last week, but market strategists think the stock market's woes began Jan. 12, when the Chinese government ordered state-owned banks to set aside bigger reserves to cover potentially failing loans and to tighten their lending standards.

dialing back on excessive optimism

China's stock market was the first to break below both its 50-day and 200-day moving averages on technical trading charts, Liz Ann Sonders, chief investment strategist at Charles Schwab (SCHW), points out. "China was viewed as the growth engine of the [global] economy. When monetary authorities needed to step in to rein in liquidity, it sent a message that the poster child for the recovery [may be] stumbling a little bit."

The market had to dial back the excessive optimism that had taken hold in recent weeks, she says.

Recent sentiment surveys still show enormous sensitivity among investors. "I don't view that as necessarily bad," Sonders says. "If we were in an environment where you couldn't do anything to pull back the optimism, that would be more troubling."

David Joy, chief market strategist at RiverSource Investments (AMP), agrees that the pullback is positive to the extent that it scares some "hot money"—speculation—out of the market. "It's a healthy development," He says. "It [signals] an adjustment process to a more mature phase of the recovery."

Rob Lutts, president and chief investment officer at Cabot Money Management, is confident that the correction can be contained. He cites a very accommodative Federal Reserve and Treasury Dept., both committed to doing whatever is needed to restart the economy. He also points to improving manufacturing and service sector data in recent weeks. Most important, Lutts says, is an estimated $3.2 trillion in cash on waiting to be deployed.