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The markets are overbought and must be corrected, says the strategist




The extension of the stock market rally is adding to optimism that a soft landing for the economy is increasingly possible despite the Federal Reserve’s aggressive rate hikes. That leads some on Wall Street to believe stocks will move even higher this year.

However, one trader says he is “not buying it”.

“The expansion is more a result of the mega-caps going crazy against a real expansion of the economy,” said Gareth Soloway, market strategist at Inthemoneystocks.com, a technical analysis platform.

“If you subtract the 7 stocks from the S&P 500 (^GSPC), the Apples (^AAPL) of the world, Google (^GOOG), Microsoft (^MSFT), Amazon (^AMZN), etc., the S&P 500 is still only up about 4%,”[ads1]; Soloway added. He believes investors are now chasing the big stocks that they had hoped to catch up on.

The Nasdaq (^IXIC) had its best first half in four decades, up about 34% year to date. The S&P 500 is up 18 percent. Even the Dow Jones Industrial Average (^DJI) hit a 52-week high this week.

Market bulls are pointing to other sectors such as Dow Transports (^DJT) as a sign of a healthier economy and a continued upward trend in stocks.

However, Soloway says disappointing factory orders, weak industrial production, slower-than-expected retail sales and tighter lending standards from banks all point to a weaker economic environment.

“There’s this dream that everything is going to work out — I just don’t see it happening,” Soloway said.

He believes the markets are overbought and must be corrected.

The markets are overbought and must be corrected, says the strategist

Retail sales in June were cooler than Wall Street had expected. REUTERS/Mike Blake

“I think overall the Nasdaq probably pulls back 10% from the runs it had, and I think the S&P — because it’s cushioned with financials, which are starting to outperform, as well as some of the other areas — it’s probably going to pull back about 5-6%,” Soloway said.

He notes that these are not major declines considering the year’s run, but they could probably get worse if a full recession were to occur.

“When we get into next year and things get nasty and the Fed doesn’t come to the rescue, that’s where I worry about breaking the October lows of last year,” Soloway said, predicting a 70% chance of that happening.

His thesis is at odds with increasingly bullish views. As Yahoo Finance contributor Sam Ro recently pointed out, strategists across Wall Street have revised up their year-end targets for the S&P 500.

Calls for a soft landing for the economy despite the Federal Reserve’s aggressive rate hikes are becoming increasingly common.

“We have maintained our non-consensus call for a soft landing since early last year,” Morgan Stanley economist Ellen Zentner wrote in a note to investors this week. “The data has continued to move in our direction, our view has only strengthened, and a soft landing has become the consensus.”

Meanwhile, Goldman Sachs recently cut its forecast for the odds of a recession in the next year to 20% from a previous 25%.

Ines is a senior business reporter for Yahoo Finance. Follow her on Twitter at @ines_ferre

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