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There’s a 'supervolcano' waiting to erupt beneath a seemingly 'beautiful' market, according to a portfolio manager

  • Barry James warns a correction is 'inevitable', even as the market looks happy on its surface.
  • A 'herd mentality' has driven up valuations, the portfolio manager warns.

Warning: A correction in the market is "inevitable" and there are three key factors that could spark chaos on Wall Street, according to James Advantage Fund president Barry James.

The investor likened the market to Yellowstone National Park's famous supervolcano, which many believe is close to eruption. Stocks continued to hit record highs on Friday, with the Dow Jones Industrial Average setting its 8th consecutive all-time high.

"Even though [the market] looks beautiful—setting new highs, good momentum, and earnings have been coming in strong, [there are] things to worry about," explained the portfolio manager recently on CNBC's "Futures Now."

Aside from the rise of passive investing, which James says is creating a "herd mentality" among investors, he also believed that the earnings picture isn't telling the whole story.

"In the 18 months ending in June, we saw companies that had no earnings, they were losing money, outperform those that were making money," said James. He highlighted many stocks' performances this year may not be reflective of their revenues.

But the biggest threat to the market rally, according to James, is the current valuation levels of stocks.

"We went back to 1994 and researched team data that said [that if we look at cyclically adjusted P/E, one out of two times] the market was down in the next 12 months, and about one out of three times it was down more than 10 percent," he said.

James' observations seem to mirror a note released more than a week ago by Goldman Sachs, which found that when valuations have been this high, 10-year returns on the S&P 500 have been either in the single digits or negative 99 percent of the time.

In other words, the market could be in oversold territory, which James does believe.

"It doesn't mean that we'll see a volcanic eruption in the immediate future, and these market peaks take a long time, but we're definitely in the latter stages of this market advance," he said. "We're going to see the inevitable correction, I just wish I could say I knew when."

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