Stock pullback coming this summer: Analysts

Get ready for a summer swoon in stocks soon.

Some analysts say a 3 to 5 percent pullback is on the near-term horizon due to increased worry about the Federal Reserve actually raising rates, high equity valuations and investor complacency. (Tweet This)

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Tightening fears

Traders work the floor of the New York Stock Exchange.
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Traders work the floor of the New York Stock Exchange.

After months of weaker data, Friday's strong May jobs report and moderate improvement in other economic indicators strengthened the case for a short-term interest rate hike in September.

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Since then, stocks have wobbled as bond yields rose to multimonth highs. Even with a slight pullback in yields, the S&P 500 on Monday fell below its 100-day moving average—indicating further technical deterioration may be coming.

"The markets have been driven the last six years by zero percent rates and quantitative easing," said Bruce Bittles, chief investment strategist at RW Baird. "I think it's mainly liquidity driven by the central bank. If that's going to change, that support isn't there."

The S&P 500 broke below 2,100 after the jobs report, setting up for this week's decline. Bittles says he's watching the 2,070 level next.

Ahead of consensus expectations for a rate hike in September—the first in nine years, the summer months could see more market volatility. Seasonally, the summer can also be weak, and many traders point to the Wall Street adage—"sell in May, buy in November"—as a reason to expect a pull back.

The Fed has been warning of market turbulence once it does begin to raise rates. Fed Chair Janet Yellen warned of it when she said in late May the Fed is likely to raise rates this year, and New York Fed President William Dudley repeated the comments Friday.

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Many also say the six-years-and-counting bull run in stocks is historically due for a correction.

For Dow Theorists who gauge market health by the Dow transports, Monday's 2 percent selloff in the transportation index adds fuel to suspicion of breakdown in fundamentals.

The transports' sluggish performance reversed slightly last week when the index posted its first positive week in four. But the Dow Jones industrial average joined it in negative territory for the year on Monday, albeit the blue chips were off 0.3 percent for 2015 versus the transports' 8.8 percent year-to-date decline.

High valuation and complacency

The S&P 500 trades about 18 times earnings, which many analysts see as on the high end of valuations.

"I think the biggest concern relative to the last 10 years is valuation," said Terry Sandven, chief equity strategist at U.S. Bank Wealth Management. "Stocks are priced with a margin of error that continues to narrow."

He said the market's recent sideways trade comes as "uncertainty is high. Investor angst is rising."

The latest weekly AAII Sentiment Survey shows record high levels of neutral sentiment—at or above 45 percent for a ninth consecutive week—and declining levels of bearish and bullish sentiment. A neutral attitude expects stock prices to stay essentially unchanged over the next half year.

Nick Colas, chief market strategist at Convergex, expects a 3 to 5 percent decline in the next four weeks.

"Momentum (is) waning. I think everybody's impressed we're not selling off more," he said Friday. "Stocks are going to play some catch-up to incremental volatility in the bond market."

Bond worries

With oil prices stabilizing and earnings out of the way, market wildcards remain bonds and the dollar.

The rapid selloff in government debt put pressure on equities, with the German DAX falling into correction territory on Monday. U.S. stocks traded slightly lower Tuesday after a market washout around the globe overnight.

"The real danger is lack of liquidity in the bond market, lack of liquidity in stocks. Nothing to do with valuation," which are symptoms rather than triggers of reversions, said Lance Roberts, general partner at STA Wealth Management.

He expects a pullback as soon as this week, especially if negative news provides a catalyst.

"The key will be when we get that correction is we do not break that long-term bullish trend," he said.

Buying opportunity

To be sure, optimists see more catalysts for a positive breakout than a negative one. Even analysts expecting a pullback mostly characterize it as a buying opportunity for a better fourth-quarter performance in equities.

David Kelly, chief global strategist at J.P. Morgan Funds, said even if a major negative event prompted a 3 to 5 percent slide, the market might pop right back up since "there's so much money that has been looking for an entry point."

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