Rising inflation could trigger a market 'mini panic' next year, warns longtime bull Jim Paulsen

Strategist Jim Paulsen on the biggest risk to the market in 2018

A longtime bull is predicting it'll be difficult to ward off a deep sell-off in the next 12 months.

The Leuthold Group's Jim Paulsen sees inflation and the 10-year yield ticking higher as the likely catalyst to stop the stock market rally in its tracks — at least temporarily.

"Can the stock market, which now trades at 20 times forward one-year earnings, handle a bond yield, let's say, going from 2.5 back to 3 percent?" the firm's chief investment strategist asked Monday on CNBC's "Trading Nation." "It will be a challenge for stocks. I expect a correction next year is likely."

His comments came as the 10-year yield was trading at its highest levels since late November and stocks were in the process of touching all-time highs. The Dow saw its 70th record close for the year, and the Nasdaq crossed the 7,000 threshold for the first time ever on Monday. Plus, the hit a fresh all-time intraday high.

"The news is just too good, which means it's doubtful to get a lot better and surprise people on the upside," said Paulsen. "It could come in a little worse and disappoint."

Paulsen, who has been a bull since the early 2016 stock market correction, warns the situation could create a groundless "mini panic."

"I think it will be scary, but I think it could represent another really good buying opportunity for another leg sometime 2019 or beyond," he added.

According to Paulsen, investors who are conservatively positioned will have the opportunity to buy on other people's panic. One of his strategies involves an under-the-radar play which could help them navigate the potentially stressful environment.

"I like the energy side of that bet. And, it's a hard one because tech is going straight north," Paulsen said. "By our estimates, crude oil stocks are now about 32 percent undervalued — the deepest they've been in this recovery relative to the price of crude oil. And, if you change that dynamic a little bit, there could be a lot of funds coming from high-growth, high-momentum technology back into the under-owned energy sector."

Strategist Jim Paulsen reveals his contrarian trade forecast for 2018