Prominent bullish strategist Jim Paulsen of The Leuthold Group now sees a stock market correction of 10% to 15% sometime in 2018, Barron's reports. Paulsen offers five principal reasons for his newfound bearishness: less economic upside, falling financial liquidity, investor complacency, rising U.S. Treasury yields and inflationary pressures.
The S&P 500 Index (SPX) was up 19.42% in 2017, while the Dow Jones Industrial Average (DJIA) gained 25.08%, per CNBC. As of December 29, the forward P/E ratios on the S&P 500 and the Dow were 20.02 and 19.77, respectively, per calculations by Birinyi Associates as reported by The Wall Street Journal. Using a different methodology, Yardeni Research Inc. derives a forward P/E of 18.3 for the S&P 500 as of December 29, and their charts indicate that this is its highest level since early 2004.
1. Less Economic Upside
The economy has shown greater than expected growth in 2017, leading to upward revisions in forecasts. Accordingly, the odds of getting positive surprises in future economic reports are diminishing. This, in turn, removes a key impetus for further gains in stock prices, Paulsen says, per Barron's December 27 story.
2. Less Liquidity
The ratio of the money supply to nominal GDP has declined recently, according to Paulsen's analysis. This contraction of financial liquidity should limit the prospects for further economic expansion, in his opinion. (For more, see also: Stock Market's 'Absurdly Good' Returns Will Worsen in 2018.)
3. Investor Complacency
While Paulsen does not believe that investors have become "giddily optimistic," he does feel that they are getting "calmer and more complacent," as Barron's quotes him. As a result, they are apt to pursue riskier investing strategies that often lead to big market drops, Barron's notes.
4. Rising Yields
Yields on U.S. Treasury Notes are up from the record lows reached in 2016, and the Federal Reserve has been raising short-term rates, as Barron's indicates. If the cost of borrowing increases more, equity investors may get nervous, Paulsen suggests. Not only would higher interest rates crimp corporate profits and make stocks less attractive versus fixed income investments, but it also would make margin loans more expensive for equity investors. The value of margin debt in the U.S. has reached record levels, and been a major prop to stock prices. (For more, see also: Stock Market's New Threat Is Record Margin Debt.)
5. Inflationary Pressures
Paulsen observes that producer prices are on the upswing, and he expects wage hikes to gain momentum in 2018, per Barron's. These inflationary pressures, in due course, are bound to drive interest rates upward.