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Bullish BofA changes gears, calls for correction

Adam Jeffery | CNBC

Another prominent market bull has joined the growing ranks of Wall Street strategists who think a correction is not far away.

Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, believes stocks are setting up for a drop of 10 percent or better in the fall. That would come after the market repeatedly dodged big declines despite numerous predictions that the two-year run without a correction was near an end.

The S&P 500 has gained 6.7 percent year to date, and Hartnett thinks the market index will finish the year higher still—the firm has a 2,000 target—but not before some turmoil.

"High cash levels say the summer 'melt-up' is not over yet," he said in a note to clients. "But with both institutional and private client allocations to stocks at multi-year highs, we think an autumn correction is increasingly likely."

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In its forecasts, BofAML likes to use sentiment indicators and portfolio allocations among Wall Street managers as contrarian indicators. When bullishness runs high, Hartnett and his team sour on the market.

Just a few weeks ago, the firm's strategists said they remained positive on stocks because portfolio allocations were barely above the 50 percent mark. That apparently has changed, and markedly.

Stock weighting has surged to 61 percent in private client portfolios—a nine-year high, Hartnett said.

"Equity price gains have boosted allocations; investor cash levels remain higher-than-normal; and investor sentiment toward stocks is far from 'irrational exuberance,'" he said. "Nonetheless, a necessary condition for an equity market correction is 'greed' and measures of greed are increasingly boosting the case for volatility and a correction in the autumn, in our view."

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For protection, Hartnett recommends investors buy puts—options allowing but not requiring holders to sell—on the Taiwanese stock market, which is up more than 16 percent in 2014.

Hartnett's call comes about two weeks after the also-bullish Jeffrey Saut, chief market strategist at Raymond James, predicted the market is likely to correct 10 percent to 12 percent before the summer ends. He argued that technical factors along with headline risk are likely to dent the rally.

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They're hardly the only ones looking for some type of pullback.

S&P Capital IQ said in a note that while it also holds to a bullish thesis and a 2,100 12-month target for the "500," technical indicators are presenting some near-term danger.

"The blue chip stock indices moved higher from support and remain well-positioned to continue to advance," the firm's analysts said in a note.

"The small caps, however, have failed to bounce from the recent test to support and are once again threatening to become an anchor to further gains as they move closer to bearish territory. In addition, breadth is showing a deteriorating picture that we haven't seen since the February pullback, and is signaling that the new highs and current rally are in jeopardy."

—By CNBC's Jeff Cox

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