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Bearish trend signals stocks are vulnerable to a 10% to 15% correction

Bearish trend signals stocks are vulnerable to a 10% to 15% correction

02 Aug 2021

The market appears to be doing something that happens ahead of corrections.

When the S&P 500, Nasdaq and the CBOE Volatility Index rise together, BTIG’s Julian Emanuel warns it’s often a precursor to a 10% to 15% pullback.

“Whenever we’ve seen that going back to the beginning of 2018, we were essentially weeks away from a correction,” the firm’s chief equity and derivatives strategist told CNBC’s “Trading Nation” on Monday. “The most recent one being last September. We think history could in fact repeat itself.”

According to Emanuel, the bearish trend has been happening for a couple of months.

“You could trade back to 4,000 [on the S&P 500],” he said. On Monday, the index fell 0.18% and closed at 4,387.16. The S&P 500 is up about 17% so far this year.

Emanuel suggests rising Covid-19 delta variant fears during a seasonally difficult period for stocks creates a more precarious situation.

“Four or five weeks ago, we really weren’t terribly concerned about the delta variant,” he said. “It’s entirely possible that the [economic] growth we expected might come a little bit slower.”

Yet Emanuel, a long-term bull, regards near-term trouble as healthy because it would give the market a key refresh.

“Its leadership which has been a bit too concentrated,” said Emanuel.

His concerns apply mainly to a handful of large cap growth and Big Tech stocks.

“At these valuations and as much as these stocks have run, they are in fact vulnerable in our view, particularly given the potential for China, as a wildcard going forward,” added Emanuel.

‘China looks very interesting as a contrarian play’

Despite his reservations about investing in U.S. companies with substantial China exposure, Emanuel wouldn’t completely ignore it either.

“Buying China here is an idea not for the faint of heart,” he said. “The options market in particular is sending the kind of near panic message that we saw at the bottom of the pandemic trough.”

Beijing has been cracking down on U.S.-listed China stocks. On “Trading Nation” last month, economist Stephen Roach, who served as Morgan Stanley Asia chairman, warned the actions signal the early stages of a cold war.

However, Emanuel believes China could be worth the gamble to investors. He notes it’s trading at the cheapest level relative to the U.S. in 25 years.

“China looks very interesting as a contrarian play,” Emanuel said. “There is definitely an opportunity there that may in fact come at the expense of these Nasdaq stocks that have been such high flyers in recent months.”