Brace your portfolio: Stocks are set to pop and then drop, says strategist Jim Paulsen

Stocks are set to fall by year-end, but not before roaring more than 9 percent higher, according to Jim Paulsen, Wells Capital Management's chief investment strategist.

He said in a recent interview that the stock market's strong start to the year is built on more than investors' enthusiasm around President Trump's proposed policies potentially buoying equities; investors are seeing a steady stream of positive economic data and earnings momentum. And the likelihood that the Federal Reserve will raise interest rates this year is somewhat of a confidence builder for equity investors from an economic perspective, he said.

Paulsen foresees the S&P 500 as poised to roar to 2,600, then plunge to the 2,200 ballpark as rates rise and finally recover a bit to close out 2017 at 2,350.

Since the market rally has a strong fundamental base right now, "I think this is going to continue on to higher levels and yields are going to move higher ... before we get a significant correction, possibly from higher levels," Paulsen said Thursday on CNBC's "Trading Nation."

He sees the U.S. 10-year Treasury yield rising to 3.5 percent, at which point higher interest rates will "bite" the stock market, sending it lower.

In terms of a market indicator Paulsen is keeping his eye on, he is watching the correlation between stocks and bonds, particularly with some historic context in mind. The two show a positive correlation right now, but since the late 1990s have turned negative during three time periods: in late 1999, late 2006 and early 2007, and in 2014.

"Every time that correlation went negative, the stock market then struggled. So I'm looking for that correlation, which is currently positive; once that turns negative again, then I think I'm going to turn more negative on the stock market overall," he said.

Back in December 2015, Paulsen expected a flat 2016, and called for the S&P to end the year at 2,050. Instead, stocks saw a substantial climb, winding up nearly 10 percent higher by year-end.


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Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

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