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The 2017 rally is about to fade, warns Wells Fargo strategist

Wells Fargo’s Scott Wren: Stocks set to stall
Wells Fargo’s Scott Wren: Stocks set to stall

The rally that the has enjoyed thus far in 2017 is set to fade in the second half of the year, according to Scott Wren, Wells Fargo Investment Institute senior global equity strategist.

"We're looking for a few headwinds in terms of valuations, and not a heck of a lot getting done in Washington," Wren said Friday on CNBC's "Trading Nation."

He added to his list of concerns that wage increases could damage corporate profit margins heading into 2018, and that some investors may also become wary about the Federal Reserve's interest rate tightening cycle (the central bank is expected to raise interest rates once more before the year's end).

Valuations, he highlighted in a note to clients, are "stretched" at 19.2 times earnings versus the median 20-year price-to-earnings ratio of 16.4 times. This is based upon his estimate for this year of $127 in earnings per share for the S&P 500.

"When we put out our target last September, the top end of that target range was 2,330. We thought we'd see the highs for this year around the middle portion of the year, and we thought it would be a little above the top end of that range," Wren said.

Indeed, the S&P 500 — trading just above 2,436 on Monday — achieved Wren's target in February, since then remaining above that level with the exception of just one session in April. In a recent note to clients aptly titled, "The Word of the Month is Reiterate," Wren wrote that his year-end target range for the index remains 2,230 to 2,330.

In other words, he expects that the market's gains for the year are behind us.

Now that the S&P 500 is trading above the higher end of his target range, "that's tough for retail investors to play," he said. Still, Wren believes that investors should continue to stay in stocks that are weighted to economic growth, such as industrials, consumer discretionary and health-care stocks, as "this cycle is not over."

"We had been overweight technology until earlier this year; cut out of it a little too early, in hindsight. But we like technology as well. So we really don't want our clients to change their positions. If we thought there was going to be a 10 to 15 percent pullback, that might be a different story. But what we want them to do right now is lean toward those cyclical sectors," Wren said.

"If the market does play out the way we think it will, really we think it's going to be a buying opportunity," he added.