Markets have overbought and need to correct, says strategist

The broadening of the stock market rally is fueling optimism that a soft landing for the economy is increasingly possible despite the Federal Reserve’s aggressive interest rate hikes. This leads some on Wall Street to believe that stocks will rise again this year.

However, one trader says he is “not buying it”.

“The widening is more a result of the insane increase in mega caps versus a real widening of the economy,” says Gareth Soloway, chief market strategist at, a technical analysis platform.

“If you subtract the 7 stocks of the S&P 500 (^GSPC), Apples (^AAPL), World, Google (^GOOG), Microsoft (^MSFT), Amazon (^AMZN), etc., the S&P 500 is still only up about 4%,” Soloway added. He thinks investors are now looking for stocks that haven’t run away like mega-caps, in hopes they will catch up.

The Nasdaq (^IXIC) had its best first half in four decades, up about 34% year-to-date. The S&P 500 is up 18%. Even the Dow Jones Industrial Average (^DJI) hit a 52-week high this week.

Market bulls point to other sectors like the Dow Transportation (^DJT) as a sign of a healthier economy and a continued upward trend in stocks.

However, Soloway says disappointing factory orders, weak industrial production, slower-than-expected retail sales and tighter bank lending standards all point to a weaker economic environment.

“It’s that dream that everything will work out – I just don’t see it happening,” Soloway said.

He thinks the markets are overbought and due for a correction.

June retail sales were colder than expected by Wall Street.  REUTERS/Mike Blake

June retail sales were colder than expected by Wall Street. REUTERS/Mike Blake

“I think in general the Nasdaq is probably down 10% from the races it had, and I think the S&P — because it’s cushioned by financials, which are starting to perform better, as well as some of the other areas — it’s probably going to be down about 5 to 6%,” Soloway said.

He notes that these declines aren’t huge given this year’s run, but they could likely get worse if a full-scale recession occurs.

“Once we get into next year and things start to go downhill and the Fed doesn’t come to the rescue, that’s when I worry about breaking the lows of October of last year,” Soloway said, predicting a 70% chance of that happening.

His thesis runs counter to increasingly optimistic perspectives. As Yahoo Finance contributor Sam Ro recently pointed out, Wall Street strategists have revised up their year-end targets for the S&P 500.

Calls for a soft landing for the economy despite the Federal Reserve’s aggressive rate hikes are increasingly common.

“We have maintained our non-consensus call for a soft landing since the start of last year,” Morgan Stanley economist Ellen Zentner wrote in a note to investors this week. “The data continued to move in our direction, our view only grew stronger, and a soft landing became a consensus.”

Meanwhile, Goldman Sachs recently cut its forecast for the likelihood of a recession next year to 20% from 25% previously.

Ines is a senior economics reporter for Yahoo Finance. Follow her on Twitter at @ines_ferre

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