Jim Paulsen, Chief Investment Strategist at Leuthold Group, has issued a warning that unfavorable warning signals are accumulating in the U.S. stock market, with expectations of a potential pullback of up to 20% in the near term.
The six signals mentioned in the report include tightening economic policy, oil prices having peaked, declining consumer confidence, divergence between stock market and economic trends, extreme bullishness among investors, and declining liquidity.
June 23 – Jim Paulsen, a well-known Wall Street figure who has long been bullish on the market and serves as Chief Investment Strategist at Leuthold Group, has recently stated that various unfavorable warning signals are accumulating in the U.S. stock market.
“Once oil prices finally peak, the ‘pressure’ on the economy and the stock market often tends to just begin heating up,” he added. “Since the warning of rising oil prices sounded, most investors have been worried about how rising oil prices might undermine the bull market. However, once oil prices reach their peak, they tend to relax and become more optimistic — which is a typical contrarian investment signal.” 3. Americans’ actual experience is far worse than what the market reflects. The S&P 500 index has remained near record highs, yet consumer confidence in the economy has been declining, breaking the long-standing correlation between the stock market and real economic sentiment. Paulsen emphasized that there is a divergence between the benchmark index and the consumer confidence index, with the University of Michigan’s indicator falling to a historic low in May. “This may be another sign that the recent rally in the stock market could be somewhat overextended,” he wrote. 4. The stock market and economic trends are diverging. The stock market appears to be outperforming the U.S. economy, largely attributable to the strong rally in what Paulsen calls “new era” stocks (i.e., technology and growth stocks). According to data from State Street Global Advisors, information technology stocks in the S&P 500 have risen 33% this year, surpassing the index’s 10% gain. Paulsen noted that due to investment spending on new-era enterprises, real GDP growth has also risen to 8% year-over-year, while the overall economy’s average annual growth rate stands at 1.1%. “Perhaps this significant divergence in success between the economy and the stock market will continue as it has in recent quarters. However, given that this divergence has become so extreme in such a short period, I doubt how much longer it can persist,” he wrote. 5. Investors are extremely bullish on the market. Investor optimism has surged, which is typically a contrarian indicator suggesting that the market may decline next. According to survey data from the American Association of Individual Investors, the proportion of stocks in investors’ portfolios is currently hovering near levels seen before the dot-com bubble burst. Paulsen stated: “Since 1988, whenever the allocation to stocks (net of cash) approaches or exceeds 50% of a portfolio, the stock market tends to underperform. Currently, this proportion is close to 55%.” 6. Liquidity is declining. Liquidity is another factor that has been closely correlated with stock prices in recent decades. Therefore, the ongoing decline in liquidity could serve as another potential warning signal for the stock market. Despite the S&P 500 continuing to trend higher, the ratio of cash to GDP for U.S. corporations and households has fallen significantly in recent years.
Paulsen pointed out that in 2008, 2020, and 2022, stock markets declined as liquidity contracted. “Once cash growth no longer exceeds GDP growth, the stock market typically falls.”
He added, “The widening disconnect between the stock market and the level of economic liquidity is a cause for concern.”
