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Stocks are long overdue for a pullback, but it will be a buying opportunity: Strategist Stovall

Key Points
  • CFRA's Sam Stovall says history shows stocks are in for trouble.
  • The S&P hasn't had a 10 percent or more slide since late 2015, ending in February 2016.
  • But he doesn't think this is the start of a new bear market.

As we close in on the end of the summer, one of Wall Street's longest-running and widely followed prognosticators says the U.S. market is "overdue" for a 5 or more percent drop.

Allen Wastler | CNBC

But CFRA's chief investment strategist, Sam Stovall, does not believe stocks are about to enter any sort of bear market.

Stovall blames "geopolitical tensions" for keeping the below 2,500, the next key level that the bull run was set to send it above. Instead the S&P hit a new high of 2,490 last week before dropping back to 2,441— that's still well above the key 100- and 200-day moving averages of 2,411 and 2,338, respectively. The index was up 1 percent to 2,466.02 late morning Monday.

In a note to clients Monday morning, Stovall notes since World War II the market has had 56 pullbacks ranging between 5 percent and 9 percent, 21 corrections involving a market drop of between 10 percent to 19.9 percent and 12 bear markets (drops of 20 percent or more). "On average" says Stovall, "only six months have separated the end of one decline of 5 percent or more until the start of the next."

The S&P hasn't had a 10 percent or more slide since late 2015, ending in February 2016.

However, Stovall warns against investor panic. His research shows that 85 percent of the time after 5 percent declines, stocks returned to rally mode. According to Stovall, "recommending that investors lighten up their exposure to equities may end up doing more harm than good to their portfolios and psyche."

The CBOE Volatility Index, often cited as a key metric of investor nervousness, jumped last week but remains near historical lows.

Like just about every other market watcher, Stovall concedes it is nearly impossible to forecast when a small drop will turn into a big one.

But he does say there are three things he's watching especially closely. First on the list, the 10-year Treasury, which is now yielding just 2.25 percent, "well below the average rate of 6.1% at market tops."

The second watch factor is valuations and that's drawing more of Stovall's attention. The average price-earnings ratio for the S&P 500 is 18.1 at market tops, it's currently at 23.5 times earnings.

Another of Stovall's warning factors is the unemployment rate which has historically dipped below 5 percent before the market hits a top, we're now at 4.3 percent.