U.S. markets are “overdue” a 10% correction, with stocks largely in overbought territory, according to James Demmert, chief investment officer of Main Street Research. Investors are also “very complacent,” which was the case before the past three major declines within this 18-month bear market, he said last week. “If the Fed raises rates at its July meeting along with what we expect will be a hawkish tone, this may be the catalyst that sparks the correction,” Demmert said in a note sent to CNBC. In addition, earnings season is getting underway and many reports will probably include lower guidance that will “make the market vulnerable from these levels,” he said. “Market sentiment is extremely confident – particularly after the passing of the debt ceiling. The VIX index of investor sentiment is at one of its lowest levels ever,” Demmert added, referring to the volatility index. “Typically, when investors are this complacent, volatility surges in the coming weeks.” Trigger for a new bull market Although many believe that the S & P 500 is already in a new bull market — after it closed up more than 20% from its 20% October bear market low — Demmert said that the bear market isn’t done yet. “We would argue that yes, we’re closer to the end of the bear market. But we’re just not there yet,” he told CNBC’s “Street Signs Asia” last week. Some investors do not consider it the end of a bear market until the S & P 500 reaches a new high. Its all-time closing high is 4,796.56; the S & P 500 was trading around 4,510 Monday. Demmert pointed to the narrowing leadership of the index — with just seven megatech stocks driving much of the gains this year. However he predicted that one trigger could drive stocks into a new bull market: money rotating out of the seven stocks and into the rest of the market “that have been completely ignored.” “It will truly be a full-fledged bull market when the rest of the stocks in the market start to participate,” he said, saying this could happen sometime in the second half of the year. “With the Fed doing what they’re gonna do in the earning season right ahead of us here, you’re probably gonna get a crack in [the] super seven coming down and [bringing] indexes down. That might be the end of the bear market and the beginning of this new business cycle bull market that we see, as inflation of course, starts to get more tempered,” he said. Three stocks to buy In the event of a near-term market correction, investors should have “some dry powder ready to go,” said Demmert. “We … think that this is a great time to have a mix of domestic and international stocks in a portfolio, as there are great values in overseas stocks, particularly in the developed countries such as Japan, France, and Germany,” he said. He named three stocks to buy: French luxury house LVMH , which he said has an “excellent” management team and resilient product lines. Japanese industrial conglomerate Mitsui , which Warren Buffett owns a stake in. U.S. semiconductor firm Advanced Micro Devices , which Demmert called a beneficiary of the AI secular tech boom.
