Noted strategist Jim Paulsen has his eye on a metric he believes may be a warning sign for the market.
While the four variables that are traditionally recession indicators aren’t lining up right now, he sees another element in play — the real earnings yield. That is the most recent 12-month period of earnings per share divided by the current market price per share.
“The real earnings yield has had a pretty good track history over the post-war period ... of kind of giving an idea of future return potential,” Paulsen, chief investment strategist at The Leuthold Group, told CNBC on Tuesday.
“Real yield sits right on the cusp of the lower quartile and half of the bull markets in post-war history — more than half actually — have ended when the real yield fell to the lowest quartile,” he said on “Power Lunch.”
That doesn’t mean he’s predicting a recession at the moment. Right now, Paulsen believes the market is highly valued and there are limits to how much higher the bull market can go.
“The real risk is if the cycle ends. That’s where the negative return potential comes in,” he said. “If the cycle continues, I think values will allow it to continue to rise.”
However, investors should be prepared.
“I’d stay in the market but would diversify much more broadly and aggressively then we have up till now,” he said.