Wall Street Bosses Say Stocks Ripe for Correction. Should Investors ‘Welcome’ the Pullback?

Stocks have rallied hard since their early April lows. The rest of the year might be a tougher run. (AFP via Getty Images)

Key Points

• Goldman Sachs CEO David Solomon anticipates a 10% to 20% drawdown in equity markets over the next 12 months.
• Morgan Stanley CEO Ted Pick suggests a 10% to 15% market pullback would be a healthy development for investors.
• S&P 500 profits are projected to increase by 11.6% this year and an additional 14.1% in 2026.

U.S. stocks might have found an air pocket this week as investors look to fly directly from last week’s megacap earnings parade directly into Nvidia’s update later this month and a Federal Reserve rate decision that they’re still hoping will give markets a final jolt into the end of the year.

With the government shutdown entering its 35th day, and shaping up to be the longest on record, investors are bereft of the jobs and inflation data they need to parse the Fed’s policy path.

At the same time, worries over the fate of President Donald Trump’s tariff strategy, and what might replace it should the Supreme Court reject his authority to use emergency powers to impose them, continue to linger.

Credit markets concerns, meanwhile, are bubbling under the surface following a series of fraud and bankruptcy-related issues that has unsettled the $1.75 trillion market and elicited a warning of “cockroaches’ from JPMorgan Chase CEO Jamie Dimon.

Add in the sky-high valuations of tech stocks, ongoing discussions of a bubble in artificial intelligence, and speculative fever in gold and Bitcoin and some would argue you have a recipe for correction.

That’s exactly what Goldman Sachs CEO David Solomon did Monday night during a financial event in Hong Kong.

“Of course, it’s likely there will be a 10% to 20% drawdown in equity markets over the next 12 months,” Solomon told the event. “That doesn’t mean the general direction of capital flows is changing, it just means that things run and then they pull back so people can reassess.”

Morgan Stanley CEO Ted Pick, speaking at the same event, suggested investors should “welcome” a pullback of between 10% and 15%, a move typically defined as a market correction, as a ”healthy development.”

Late entrants to the current bull market, now entering its fourth year, might not think such a retreat would be revitalizing, but the underlying strength in equity markets, and the economy at large, suggests it could be easily weathered.

Stocks have risen more than 36% from their early April lows, and are sitting on gains of nearly 70% since the launch of the AI-powered ChatGPT chatbot in November 2022.

Looking ahead, stocks are certainly carrying rich valuations, with the forward earnings multiple of the S&P 500 pegged at 23.1 times, but there is some justification for that.

Collective S&P 500 profits are forecast to rise 11.6% this year, and a further 14.1% in 2026, with efficiencies from AI investments slowly working their way into the bottom line of corporate America over the coming year.

Tailwinds from the One Big Beautiful Bill Act, a Fed that likely will turn dovish under new stewardship next year, and an economy that remains a long way from recession will add further support to markets.

But stocks don’t always go up, and even when they do, they aren’t always committed to a straight-line advance. That’s especially true when a rally relies on just a handful of companies.

“When an index is moving higher, and market breadth measures aren’t keeping up, or even worse, deteriorating, it provides a warning sign of emerging cracks in the market’s foundation,” said Adam Turnquist, chief technical strategist at LPL Financial.

Early market action Tuesday suggested investors are alive to the risk of those cracks in the rally’s facade, with all major indexes trading firmly in the red and the Cboe Group’s VIX volatility gauge rising 13% to the highest levels in two weeks.

“Awareness of the environment we’re in has become so widespread that it’s starting to pose a risk in itself,” said Giuseppe Sette, president of markets analytics group Reflexivity. “Investors should keep a close eye on any potential retracement that could occur in the coming weeks.”

Write to Martin Baccardax at martin.baccardax@barrons.com