The stock market is stuck between a rock and a hard place, with only a narrow window open for another leg higher absent a correction, James Paulsen, chief investment strategist at Wells Capital Management, said Friday.
"We've got two conditions that make it difficult," he told CNBC's "Squawk Box." "We've got corporate profit margins which are close to post-war record highs, and we're also nearing full employment. So it's difficult to find a growth rate that is good for the stock market."
Paulsen outlined a chain of events that could lead to a correction.
If the economy doesn't pick up because profit margins are already maximized, then corporations won't be able to juice earnings through rising margins, he said. In the event of that, earnings will be tied to sales, and if sales don't grow, then earnings will suffer, he said. That's a problem in a market that is trading at 18 to 19 times earnings.
Even if the economy picks up, markets may be unable to avoid a correction because the improvement will aggravate cost pressures because the United States is at full employment or very close, he said. That will lead to rising wage and price pressures, bigger jumps in interest rates, and concern about margin erosion and multiple contraction.
"It's very hard to find a Goldilocks growth rate right now that is good for the stock market, and I think that puts a very narrow window for a sustained advance, so maybe we're going to correct before we go higher," Paulsen said.
One of the only ways to find growth at full employment is to resurrect productivity, he said.
"Productivity is kind of the elixir of the capitalist system," he said. "It takes a fully employed labor market and stretches that resource to allow you to grow without interest rate inflation consequence. It takes maximal profit margins and stretches the earnings cycle, and that's what we need."
The United States could see productivity rise in the next several years, Paulsen said, but he doesn't expect it to show in the next 12 months due to lack of investment.