Veteran strategists are urging investors to be wary of a stock market correction triggered by risks as glaring and dangerous as the 800-pound gorilla.
Scott Wren, senior global market strategist at Wells Fargo Investment Institute, recently noted that the market is unusually narrow. He found that the top five stocks in the S&P 500 index accounted for nearly three-fifths of the exceptional 10.6% gain year-to-date through May 31. A few of the index’s mega-cap growth leaders rose 40.8%, while the rest of the stocks rose less than 5%.
“Let’s consider the 800-pound gorilla in the room: the handful of stocks driving the majority of the SPX’s returns this year,” Wren wrote in a June 20 note. “It is clear that the upside this year will be very narrow.”
While a market dominated by top stocks can continue to rally for weeks or months, Mr. Wren warned in a recent interview that such gains will ultimately be unsustainable.
“Historically, if you look at a lot of cycles, when the market gets very narrow and the market is rising, it comes to a meaningful top,” Wren told Business Insider.
Steve Sosnick, a fellow strategist at Interactive Brokers, likened the investor shift toward big tech companies to “playing Jenga in the stock market” in a June 20 note. When the gap is narrow, Sosnick wrote, the market becomes increasingly top-heavy and unstable, like a tower of wooden blocks, “as part of the base is used to build the tower higher.”
As anyone who has played Jenga can attest, stock prices rising without a solid foundation can quickly lead to a crash as big and dramatic as the rise, and that fate could soon befall the S&P 500, Wren warned.
“This trend is going to continue until it doesn’t,” Wren said. “And it’s going to break, and when it does break, it’s probably going to happen pretty quickly, so we want our customers to be prepared for that.”
When the economy weakens, stock prices fall sharply.
Wren said history teaches that small market rallies often end with declines “well in excess” of 10%. Such a sell-off would send the S&P 500 below 5,000 for the first time since April.
“A 10% drop is certainly something we can expect,” Wren said. “It’s not a bold prediction given the upward trend so far.”
Although Len expects a big drop, he is optimistic about U.S. stocks in the medium term. This is mainly because, unlike the tech bubble, the stocks that drive the market are highly profitable. Len doesn’t think the bull market that has been running since October 2022 will end, indicating that a 20% drop is unlikely. A 30% drop is even less likely, he said.
Wren’s somewhat cautious stance is reflected in his firm’s end-of-year target for the S&P 500 at 5,200, about 5% below current levels, and Wells Fargo Investment Institute’s end-of-2025 target of 5,700, implying the index rises just 4% over the next 18 months.
While stocks are currently trending higher, if the momentum in this market stalls, a sharp drop is likely to follow. In the short term, Wren predicted that the S&P 500’s 200-day moving average of about 4,840 would be a logical downside target.
As for when a pullback might come, the global strategist said he’s keeping an eye on it this summer, but isn’t sure about the timing. The stock market has shown it can hold up despite tight market ranges and highs. Wren is now watching for signs of euphoria.
“They just jump in when all the retail investors are invested and afraid of missing out,” Wren said. “Usually that’s the high point, but we’re not there yet.”
In addition to market-driven narrowness, Wren is concerned about slowing economic growth. While he doesn’t foresee a recession, he sees U.S. GDP slipping below 2% for the next few quarters as consumer spending and the labor market weaken. That won’t help broaden the market, he said.
Analysts at Wells Fargo Investment Institute expect S&P 500 companies to earn $260 a share in 2025, compared with a consensus forecast of $280, so earnings growth may also slow.
“I don’t think that’s going to happen,” Wren said of the earnings forecasts. “So I think the combination of lower consumer spending, a slowing economy and earnings forecasts not happening is likely to cause at least a significant correction. We view that as a buying opportunity.”
5 ways to invest before a correction
While Ren acknowledges that the drop in share prices would have already created a good opportunity to enter the market, he expects shares to recover.
“We’re trying to be patient here,” Wren said, “but it’s hard to be patient when the S&P 500 is hitting multiple all-time highs.”
While U.S. stocks overall are expensively valued, especially big names in the technology and communications services sectors, Wren is bullish on some potential under-the-radar winners in the AI ​​space. Industry and materialas well energy and health care Company.
Artificial intelligence (AI) trading has become all the rage in the market since the start of 2023, but as Goldman Sachs strategists recently pointed out, tech stocks aren’t the only way to trade with AI.
Rather than pouring money into Nvidia after its stock price soared, Ren hopes to indirectly capitalize on the company’s success by investing in companies that build data centers and provide the raw materials.It remains to be seen which companies will be the biggest winners from the AI ​​boom, and many of today’s leaders will inevitably follow the same path as Pets.com, Ren said.
“There are probably individual stocks that are in bubbles, but the sectors I wouldn’t call bubbles are industrials and materials, and companies are [are] It’s going to be building all these things, all this infrastructure,” Wren said.
Len’s preference for economy-sensitive sectors may come as a surprise, as he expects GDP growth to slow significantly. He believes AI and infrastructure development across the U.S. will support these sectors. As for energy catalysts, Len said he expects oil prices to remain above $70 a barrel as supplies are still limited.
Investors worried about a sell-off could turn to health care, which has lagged the market this year but remains a defensive sector with strong long-term prospects as the world’s population ages. He’s less interested in utilities, a defensive group that has exposure to AI and is already performing well.
Outside of stocks, Ren is optimistic. Short-term fixed incomeHe acknowledged that the safe haven hasn’t generated profits this year, but he has secured higher yields and is prepared to do so again if the group remains weak.If interest rates fall, short-term bonds should soar.
“We think it gives us an opportunity to not only buy equities at lower levels but also lock in longer-term bonds,” Wren said.
