Correction to Bear Market? What are the risk factors?

As of last week, the US stock market is officially in correction (defined as a decline of 10% or more from a previous peak.  This table shows the extent of the decline by sector with Consumer Discretionary (Housing, automobiles) and Financials already in bear market territory (defined as a decline of 20% or more from the previous peak.)  As this is the 4th significant downdraft in stocks in the last 12 months (also February, August and November), investors are feeling particularly skittish.  

Financial service stocks, which peaked in February 2007, accelerated sharply downward in October 2007 as the major banks, starting with Citigroup, announced unprecedented losses on investments in Collaterized Debt Obligations (CDO's).  Citigroup announced $6.5 billion in losses in October and projected losses of $11 billion in November.  Brokerage house estimates of Citigroup's losses rose steadily over the last two months. 

As Citigroup is one of the biggest losers in the CDO meltdown, we've been waiting with trepidation for today's earnings report. Citigroup's reported write-off was $18 billion on CDO's and another $4 billion on related credit instruments.  Earnings slid 78% to $0.91/share, less than half of estimates, so a pretty disastrous report.  The dividend, as expected, was cut 41%, although the current yield of 4.77% remains one of the highest in the S&P 500.  There is the perception that the new management team, in place for only 5 weeks, wanted to stuff as many problems into the current report as possible, setting the stage for upside surprises later this year.  After the previous earnings report, Citigroup stock declined 31% in a day.  Although today's news is much worse, the stock is down 7.3%, touching a level not seen since July 2002.  Although Citigroup received a host of down-grades today, we actually think that the stock will be higher 6 months from now.