A stock market correction is coming as rates, inflation, and valuations darken the outlook for investors, strategist says

• The S&P 500 is in for a 5% drop, according to CFRA's Sam Stovall.
• The veteran strategist warned of a veteran backdrop for stocks.

The stock market is in for a correction, as a trio of unfavorable factors will weigh on equity prices, according to Sam Stovall, chief investment strategist of CFRA Research.

The Wall Street veteran pointed to the strong performance of stocks so far this year, with the S&P 500 up 15% in 2024. However, the benchmark index is poised to dip 5%, he predicted, thanks to the bearish setup in interest rates, inflation, and stock valuations.

Inflation is declining but is still above the Federal Reserve's 2% target, leading central bankers to project just one rate cut by the end of the year.

Higher rates have triggered the longest-ever inversion of the 2-10 Treasury yield curve, the bond market's famous gauge of a coming recession. The indicator, which flashes when the 2-year yield surpasses the 10-year yield, has been a reliable recession signal throughout history, and economists have said that this time likely won't be different.

Stock valuations are also high by historical standards, which hints at future downside. The S&P 500 is priced at a 32% premium compared to its average price-to-earnings ratio over the last 20 years, Stovall noted. Tech stocks, which have dominated the market in recent years, are trading at a 68% premium.

"I think we're really stretched and we got to see some upward revisions to earnings estimates, I think, in order to justify that," Stovall said in a recent interview with CNBC.

Stocks could see their first "crack in the ice" in the tech sector, he added, pointing to lofty valuations among mega-cap tech stocks.

"It's only been tech that's been outperforming the market. I sort of feel this is a jumbo jet that's flying on one engine, and you wonder how long it will stay aloft," he warned.

Other forecasters have warned of limited upside to the market as stocks — particularly tech stocks — continue to climb higher. According to one valuation metric, the stock market looks to be the most overvalued since 1929, which could pave the way to a steep correction, elite investor John Hussman warned.