The S&P 500 may have to drop another 10 percent to sustain the bull market, warned Wall Street veteran Jim Paulsen as stocks were making back some of Wednesday's market plunge.
Paulsen, chief investment strategist at The Leuthold Group, explained his reasoning, and it started with concerns about a slowdown in the economy, a trend he's been warning about for a while now.
"If we drop more than Wall Street expects to 2 percent growth or something, I think the 2019 earnings numbers go away," he said on CNBC's "Squawk Alley" Thursday. "Also, recession fears will spike given how late we are in this [economic] cycle."
The stock market needs to find a lower valuation, Paulsen said. "Then it can withstand higher [bond] yields and growth with higher yields."
Even though earnings have been "fantastic," they haven't helped the stock market, Paulsen argued, saying that based on profit estimates the price-to-earnings ratio for the S&P 500 should be about 15 times. That translates into about 2,400 on the index, which opened Thursday just under 2,700 after Wednesday's 3 percent rout.
"I think we're going to have to get to those levels, down to around 15 times on slower growth in order to sustain this bull," Paulsen said, adding it's hard right now to find the just right Goldilocks level for the market.
Meanwhile, the fascination with fiscal stimulus has masked the massive monetary tightening of the past 12 to 18 months in the form of spiking in short-term and long-term bond yields in the U.S. and overseas, he said.
Paulsen also cited a number of other factors that could be signalling slower economic growth ahead.
"Look at autos, look at housing activity, durable goods in general," Paulsen said. "Look at the under performance of all the cyclical sectors including consumer discretionary and financials ... and the outperformance of defensives."