Leuthold's Ramsey sees 'correction' soon because recent 'burst of bullish betting' has gone too far

Key Points
  • Leuthold CIO Doug Ramsey cited growing highs in investor sentiment as a contrarian indicator that the S&P 500 and Dow could see as much as an 8 percent sell-off within six to eight weeks.
  • Ramsey said he still likes big technology stocks.
  • The CIO expects the S&P 500 to rebound and finish the year in the 2,550 to 2,600 range after the coming pullback.
Leuthold's Ramsey sees 'correction' soon because recent 'burst of bullish betting' has gone too far

Leuthold Chief Investment Officer Doug Ramsey is expecting a market downturn and a spike in volatility as early as the next six to eight weeks.

Ramsey cited growing highs in investor sentiment as a contrarian indicator that a short-term sell-off may be at hand. The strategist told CNBC in a phone interview that he expects the and Dow Jones industrial average to drop as much as 8 percent from here.

And Ramsey noted in the interview that the losses will be bigger for "small caps, the high beta stocks."

The market bulls have been on a tear this year, with technology leading the charge. The S&P 500 is up over 10 percent, while the Dow Jones industrial average recently broke a 10-day winning streak and is near its all-time high above 22,000 points.

"Our sentiment work revealed a burst of bullish betting during the Dow's nine-day winning streak," wrote Ramsey in his August report, out to clients this week. "Conditions have slipped into place for at least a short-term correction."

But Ramsey isn't worried that a sell-off will lead to a longer bear market. He believes the S&P will claw back to 2,550 by year's end. (It closed at 2,474.02 on Wednesday.) Still, the CIO underscored the market's tendency to "lay an egg" in years that end in 7s, specifically in late summer and early fall.

"It goes without saying that 'Year Seven' tends to see a massive volatility spike," he wrote. "We wouldn't vacate the stock market based on this pattern alone, but we would exit any 'short volatility' strategies during this window."

As Ramsey points out, sentiment peak usually precedes price peak. And sentiment is at the "warning threshold."

Bullishness in recent Investors Intelligence surveys has topped 60 percent recently, the highest levels since late February. Analysts have cautioned that large spreads between bulls and bears, who are at just 16.5 percent, are indicators of extreme complacency and upcoming danger.

Though many investors see tech stocks as overvalued, Ramsey is confident that classic large-cap companies would carry the market through the short sell-off toward recovery. Technology has led the markets this year, up 23 percent through Wednesday's close; leaders include Activision, Nvidia and Facebook.

"There's plenty of time [for a recovery]," Ramsey told CNBC. "We've seen transport stocks at highs just a few weeks ago. Financials, too, were at highs just on Monday … the market has considerable breadth."

"The most likely scenario would be new, narrower highs in big mega-tech stocks — the FANG group," he said. "Historically, there is a very strong tendency for momentum stocks to do very well in the last innings."

Ramsey concluded by reiterating his higher S&P year-end target, but assured investors of his uncertainty in the near-term.

"We're going to play it cautious in these next few weeks."