Expect a 10% or worse correction in U.S. stocks by mid-August, says this forecaster with a proven track record

I devoted two columns to Martin’s forecasts over the past year, and both proved prescient. In May 2020, I concluded that “the stock market… is stronger than even the most bullish investors believe.” In January of this year, I wrote that the market was still “firing on all cylinders.”

In an interview on July 14, Martin said the U.S. stock market today is most definitely not firing on all cylinders. In fact, he said, the market’s internal health is now worse than at any time since October 2018. That was the beginning of a 20% decline in the S&P 500 SPX, -0.33% and a 26% decline in the small-cap Russell 2000 Index RUT, -0.55%. (Martin anticipated that decline as well; see my Oct. 4, 2018, column.)

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Martin hastened to add that the market’s internal health is not as bad today as it was in 2018. This time around, he is forecasting a decline of 10% or more for the leading U.S. stock indexes. As for timing, he says that the decline could begin at any time, but he anticipates that it will begin no later than mid-August.

The source of the market’s ill-health

Martin bases his sobering forecast on the increasing divergences within the U.S. market, as indicated by fewer and fewer stocks participating in the headline-grabbing strength of the leading indices. One indicator of these divergences is the growing number of stocks hitting new lows, for example. On Wednesday of this week, for example, even as the Nasdaq 100 NDX, -0.71% and the S&P 100 OEX, -0.37% indexes were hitting new highs, many sectors were registering a plurality of new lows.

This was particularly evident in the small- and mid-cap sectors, as represented by the Russell 2000 index. On July 13 there were more new lows than new highs within that index for the second consecutive day. In Martin’s data for the Russell 2000’s new highs and new lows, which extends back to June 2000, what happened this week has happened only three other times — in September 2014, July 2015 and October 2018. In all three cases, three months later both the S&P 500 and Russell 2000 were at least 10% lower.

Martin reports that the only area of the market not showing dangerous divergences right now is the large-cap dominated S&P 500. Except for that sector, he says that the “stock market’s current internals are some of the worst I’ve seen in decades.”

Martin added that these severe divergences are occurring as equities are severely overvalued — with some stocks in bubble territory. This means that, when the market does decline, it’s likely to fall more than it would otherwise.

Adding fuel to the fire, he continued, is the too-bullish investor sentiment that prevails right now. As contrarians remind us, such sentiment extremes mean that the path of least resistance for the market is down.

To be sure, Martin concluded, stocks have been overvalued for some time now, and bullish sentiment has been at or close to extremes. The missing piece was market divergences. That piece is now in place.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]

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