Markets overbought and due for a correction, says strategist

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The broadening of the stock market rally is raising optimism that a soft landing for the economy is increasingly possible despite the Federal Reserve’s aggressive interest rate hikes. That is driving some on Wall Street to believe stocks will move even higher this year.

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

“The broadening out is more a result of the mega caps going up insanely versus a real broadening of the economy,” says Gareth Soloway, chief market strategist at Inthemoneystocks.com, a technical analysis platform.

“If you subtract the 7 stocks out of the S&P 500 (^GSPC), the Apples (^AAPL) of the world, Google (^GOOG), Microsoft (^MSFT), Amazon (^AMZN), etc, the S&P 500 is still only up about 4 %,” added Soloway. He believes investors are now chasing the stocks which hadn’t run away like the mega cap names, in hopes they will play catchup.

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

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

However, Soloway says disappointing factory orders, weak industrial production, slower-than-expected retails sales, and stricter lending standards from banks all point to a weaker economic environment.

“It’s this dream that everything is going to work out — I just don’t see it happening,” said Soloway.

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

June retail sales came in cooler than Wall Street had expected. REUTERS/Mike Blake

June retail sales came in cooler than Wall Street had expected. REUTERS/Mike Blake

“I think in general the Nasdaq probably pulls back 10% from the runs that its had, and I think the S&P — because its cushioned with financials, which is starting to perform better, as well as some of the other areas — it will probably pull back about 5-6 %,” said Soloway.

He notes these aren’t huge declines considering this year’s run, but they could likely to get worse should a full blown recession occur.

“Once we get into next year and things start to get nasty and the Fed doesn’t come to the rescue, that’s where I worry about breaking the October lows of last year,” said Soloway, forecasting a 70% chance that it will happen.

His thesis is contrarian to increasingly bullish outlooks. As Yahoo Finance contributor Sam Ro recently pointed out, strategists across Wall Street 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 becoming more common.

“We have maintained our out-of-consensus call for a soft landing since early last year,” Morgan Stanley economist Ellen Zentner wrote in a note to investors this week. “The data have continued to move in our direction, our view has only strengthened, and a soft landing has become consensus.”

Meanwhile Goldman Sachs recently reduced its forecast for the odds of a recession in the next year to 20% from a previous 25%.

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

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