This underestimated risk could spark the next big market slide

Stocks may be coming off their best day in two weeks, but Ned Davis Research's Ed Clissold sees near-term trouble ahead.

While midterm election years are typically associated with third quarter pullbacks, his latest indicators suggest the ultimate catalyst could come from abroad. According to Clissold, international issues are just as likely to drive corrections in midterm years as domestic issues. In a world where emerging markets are struggling and trade war fallout is lurking, this year may be even more vulnerable.

It's a risk that's largely underestimated on Wall Street, Clissold said.

"We're certainly in the weakest time of the year seasonably for the market," the firm's chief U.S. strategist said Tuesday on CNBC's "Futures Now." "We wouldn't be surprised if over the next several weeks there's some choppiness to the market."

The Dow had its best day in two weeks on Tuesday. It's now 2.43 percent off its all-time high hit on Jan. 26. The S&P 500 saw its best daily performance since Aug. 29, closing at 2,887.89.

Clissold, whose S&P 500 year-end target is 2,900, sees a 5 to 10 percent pullback. However, he predicts stocks would recover strongly by fourth quarter.

"The U.S. is really a domestically oriented economy. If we're going to run into big trouble, it's of our own making. It's not really going to come from overseas. So, can it cause a hiccup? Yes, but it's not necessarily going to be a driver of a major bear market," he said. "The strongest time of the four-year cycle is actually from around midterms into the beginning of the pre-election year."

But investors may not be completely out of harm's way. Clissold contended the second half of pre-election years carry higher probability of deeper pullbacks.

"As we move into next year, we're going to have earnings growth that's going to be significantly lower," he said.

He added that higher interest rates and slowing economic growth could also leave the bull market flustered.

"That's the recipe for that bigger decline again, of our own making, not a short-term issue from overseas," Clissold said. "That could set the stage for a bigger correction. You know, a 20 percent or larger correction. There's a lot that has to happen to get there. So, that's not necessarily a prediction, but as we move deeper into 2019, that risk becomes greater."

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