A One Time Super Bull Is Getting Worried About the Stock Market
Jim Paulsen is removing himself from the ranks of the stock market’s biggest bulls.
The Minneapolis-based chief investment strategist at the Leuthold Group has shifted his views in recent months and now expects a market correction of about 10% or 15% at some point next year. And he doesn’t see the buy-the-dip crowd rushing in at full speed when it’s over either, as he believes the stock market may not end 2018 higher than where it began.
Mr. Paulsen has been optimistic about the economic recovery and stock market for most of the eight-year-old bull market, even when many others were skeptical. The change stems in part from what he sees as rising market sentiment during a time of heightened valuations, as well the belief that slowly building inflation pressures could add a roadblock for stocks next year.
Mr. Paulsen’s views are notable at a time when investors are finally starting to show some enthusiasm about the stock market. At the end of a year in which the S&P 500 has defied expectations and climbed almost 20%, many see more gains in store as the economy picks up steam, earnings keep growing, and a Republican tax-code overhaul looks set to add to corporate profitability.
Analysts at Wall Street banks, for example, expect the S&P 500 to finish 2018 at 2854 on average, up 6.5% from Tuesday’s close of 2681, according to Bespoke Investment Group. Some see the benchmark index crossing above 3000. Mr. Paulsen, for his part, doesn’t dispute the traditionally positive shifts happening in the economy, but he believes their boost to the stock market may not play out as expected.
“There has been a lot of change in the attitude about how good or bad the economy is,” he said. “As you changed that attitude, it went through stocks and revalued them higher. It’s done.”
Mr. Paulsen, who spent two decades at Wells Capital Management before moving over to Leuthold this year, disputes that he’s always been a market bull. He notes that he turned bearish ahead of market crashes in 1987 and around the turn of the millennium, though he says he missed the 2008 market collapse and stayed bullish in its wake. More recently, he called for a market correction in 2014 around the time the S&P 500 crossed above 2000.
Mr. Paulsen’s more cautious tone in recent months reflects new challenges that he believes the market faces going into the new year. Here are some of them:
As economic data get stronger, economists’ expectations for those readings are getting higher as well, removing the potential for positive economic news to surprise the market and jolt it higher.
Financial liquidity, which supports economic activity, has been contracting recently, according to his measures of money supply relative to nominal gross domestic product.
Sentiment about the market is getting stronger, which can lead to the type of risky investment activity that often ends with a big market decline. He says: “I’m not saying people are giddily optimistic, but relative to what we’ve done in this bull, they are far calmer and more complacent compared to what they’ve been.”
Yields on benchmark Treasury notes, though they’re flat on the year, have risen a lot from record lows reached in the middle of 2016. Short-term rates have been rising as well as the Federal Reserve has been lifting rates. If borrowing costs rise much further, it could start to make stock investors concerned.
Inflation, the missing ingredient in the economic recovery and one reason rates are so low, is picking up. He points to rising producer prices, a gauge of prices that U.S. companies receive. He believes U.S. wages, which have been sluggish throughout the economic expansion, could rise more in 2018.
For decades Mr. Paulsen been offering up market commentary that regularly gets picked up by the financial press. The research that he presents to clients, which typically includes a mix of economic and market analysis, is often filled with extra exclamation points and question marks. It’s his way of making fun of the rules of the English language, he says, which he’s always thought to be random in ways that mathematical formulas are not.
This time, he isn’t calling for a recession or a bear market, typically indicated by a decline of 20% or more from a peak. That’s partly because he doesn’t yet see widespread signs of excessive behavior among investors. But he believes small shifts in markets and the economy could rearrange the optimistic narrative around the stock rally and send the market in the other direction.
“Most years, people start the year defensively,” he said. “This year it feels like people are in, waiting for it to go higher. There’s a difference in risk in the stock market for those two attitudes.”
When Mr. Paulsen started working at Leuthold, he joined forces with his old friend Doug Ramsey, with whom he’s shared lunch regularly for years. Their views are often at odds with each other, with Mr. Paulsen taking the more optimistic outlook in recent years and Mr. Ramsey taking a more cautious view.
“Right now I don’t think we’re that far apart,” Mr. Ramsey said.