After stocks hit record levels this week, many analysts believe the market is nearing a top, setting the stage for another pullback.
"Technically, we're over-bought, and it looks like the market is due for some sort of correction," said Sean Clark, chief investment officer for Clark Capital Management. "However, if it does correct, I think that would represent a great buying opportunity because we believe the market is going to move higher throughout the rest of this year."
It's not hard to see why many see a selloff coming. A number of stock market averages, including the Dow Jones Industrials, hit record highs this week. The Nasdaq is trading at a six-year high, while the S&P 500 is at a 6 1/2 year high.
"I believe this market is going to crest soon," said Robert Pavlik, chief investment officer for Oaktree Asset Management. "I think the market has been driven largely by the earnings reports of some of the largest S&P 500 names that have been able to beat their lowered expectations--'lowered' being the key word."
"There's a reason why they say, sell in May and go away," said Marc Pado, U.S. market strategist for Cantor Fitzgerald. "We have to look forward and ask what is the next major catalyst, which is likely to be a rate cut, but not until August or September. That's too far away. So after taxes, we start feeling a little poorer and the market tends to settle back in May and, I think, we get a 3% correction."
What's different from the February selloff, however, is that most experts already believe stocks will resume rising after the pullback.
"Equilibrium Has Been Found"
"I think six weeks ago, we had a handful of concerns, whether it was a China slowdown, a yen carry trade, a subprime mortgage meltdown, or residential real estate blowup or a consumer that wasn't going to spend money any more," said Arthur Hogan, managing director at Jefferies. "The market tended to price in the worst case scenario. What we are finding as a lot of things unfold (is that) the worst case scenario is not justified and some sort of equilibrium has been found."
So while many analysts are optimistic about stocks for the year, they say investors should be prepared for volatility, particularly with the markets at these levels.
"I think we are going to see a stair-step reaction," Frederic Dickson, chief market strategist at D.A. Davidson & Company, told CNBC.com. "After the market goes up, then there is a little bit of consolidation and we reassess what's next. I think the market has shaken off the notion of going significantly lower, which is how some were feeling in February. We are reasonably optimistic, but we will have some speed bumps along the way."
Earnings have been mostly positive so far, but the market could turn quickly if big-name companies disappoint. And analysts say there are plenty of other potential obstacles for stocks.
Next week, investors will have new housing data to analyze, plus the latest Gross Domestic Product report, in addition to a fresh round of earnings.
Peter Boockvar, equity strategist for Miller Taback, said the market's concern this past week about China growing too fast was misplaced, but investors should be concerned about the U.S. economy slowing too much. He believes next week's GDP number may be below 2% for the first time since 2003.
"(U.S.) markets have shown strength on the hope that the housing market has stabilized, the hope that the labor market will remain strong and the hope that the consumer is not going to fall off a cliff," said Boockvar. "I don't think these hopes are going to be realized."
Inflation Still a Concern
Pavlik said recent economic reports appear encouraging, but the PPI, CPI and PCE show that inflation is still a concern.
"I think the market is going to take a look after this earnings season and realize we're not in a sweet spot, but we're coming into an economy that's in mid-cycle slowdown," said Pavlik. "We have lower reports for earnings, lower guidance for GDP, inflation becoming a problem, and weaker housing, manufacturing and business spending. Plus, with oil and gas prices going up, there's bound to be a pullback."
Richard Suttmeier, chief market strategist at RightSide.com, believes stocks will be derailed by a banking system that will be overburdened by the weak real estate market.
"There is too much exposure in the banking system to real estate-backed loans," Suttmeier told CNBC.com. "The bigger banks are able to camouflage these issues, but not the smaller banks. The bailout money is going to dry up, and you don't have enough private equity to buy it all up. When you have a market that's over-leveraged, with risk appetite so high, valuations so stretched and technical so strong, I don't know how many events you can recover from until the towel gets thrown in."
However, David Doll, CEO at Kanaly Trust Company, believes the markets can still power forward from here.
"We see the catalyst being large-cap stocks," said Doll. "We see a re-orientation to the markets because of the ability of larger companies to really deliver to shareholders at this point of the economic cycle. They've got a lot of cash on their balance sheets and they are willing to share that in the form of buybacks or even dividends."
Gems in Healthcare
D.A. Davidson's Dickson says investors can still find gems in healthcare.
"Drug companies were lagging performers for the last couple of years," said Dickson. "We had positive surprises from Eli Lilly and Merck. The market is realizing that the healthcare product pipeline has improved, but also that these international drug companies will be beneficiaries of that weak dollar."
Suttmeier, who is forecasting a recession by 2009, is encouraging investors to lighten up on stocks.
"There are always going to be trading opportunities in stocks, but I advise investors to put their money into Treasuries," said Suttmeier. "I think if you don't take 50% out of your stock portfolio and put it into that U.S. Treasury mattress, you're making a huge mistake."
Phyllis Burke Goffney is a News Editor at CNBC.com. She can be reached at firstname.lastname@example.org.