A bad August for the markets may usher in an even worst September based on seasonal trends.
But long-time bull Jim Paulsen is positioning for a breakout by year's end because he believes dread is oversaturating the market.
"We almost have a fear bubble. That's our primary thing that sits out there for me," the Leuthold Group's chief investment strategist told CNBC's "Trading Nation" on Friday. "People are not loading into stocks even though we're really close to market highs. They're loading into bonds even though they have close to record low yields... The behavior just screams fear."
August marked the market's second losing month of the year. The Dow and S&P 500 were off almost 2% while the tech-heavy Nasdaq fell by about 3%. In July, stocks were hitting all-time highs.
Paulsen, who correctly predicted the stock market would sharply rebound from last December's historic pullback, expects evidence of a stronger economy will calm fears.
"I think the odds favor all of the policy stimulus we've introduced: fiscal stimulus, policy stimulus, monetary growth, lower yields," he added. "It's been about six to nine months lag time, and I think it's going to start to improve economic reports."
According to Paulsen, that'll be what ultimately paves the way to new record highs.
"If you pierce a fear bubble, do you have a big rally? And, I kind of think that's one of the contributing factors to the upside," said Paulsen. "If we find out it turns out better than feared, many, many portfolios are under allocated to risk assets and will have to re-adjust themselves trying to get more risk which could drive risk assets a lot higher."
Yet, he acknowledges the market is in a late-stage economic growth cycle. However, he isn't going into recession countdown mode like many of his Wall Street peers.
"We've grown slowly close to the 2% stall speed we used to worry about the entire recovery. We're at full employment with 4% unemployment," Paulsen said. "We're in the longest recovery ever now in U.S. history. So there are certainly characteristics of being near the end. But character wise, I just don't see the overextended nature mainly because we've been so conservative."
