- Market sentiment and uncertainty over Fed policy is set to improve next year, which could give a boost to stocks, Jim Paulsen said.
- Uncertainty is higher than 82% of the time since 1987, and market bullishness is nearing a record low.
Despite fears of more aggressive Federal Reserve rate hikes, stocks could be poised for "amazingly strong results" as uncertainty over central bank policy and investor sentiment improve next year, according to Leuthold Group's Jim Paulsen.
This year has been brutal for markets, with the S&P 500 sliding over 20% amid high inflation and expectations of higher interest rates. But a turnaround may be near, Paulsen said in a note on Thursday, pointing to high levels of policy uncertainty and low levels of investor sentiment, which could raise odds that the central bank will soon ease up on monetary tightening.
The US Monetary Policy Uncertainty Index, a measure of Fed uncertainty in top US news publications, is higher than 82% of the time since 1987, the year an asset bubble burst and sent stocks plunging on Black Monday. But that's likely to improve over the next year, Paulsen said, as inflation pressures are showing signs of easing, building the case for the Fed to soften its pace of rate hikes.
A number of economists have urged the central bank to ease up on fears of overtightening the economy. Wharton professor Jeremy Siegel noted that inflation was being "overstated" in the official statistics, and inflation-leading indicators, like housing prices, are falling rapidly, although that won't show up in the Consumer Price Index for another 18 months.
Paulsen also pointed to the Bulls Less Bears Sentiment Index, a measure of investor bullishness that's currently close to beating the 1990 record low. That means investor sentiment "cannot get much worse than it is now," he said – a factor that could also push the central bank to soften its hawkish tone and spur more optimism for the market.
If those measures improve in tandem, it spells good news for stocks.
"Obviously, the stock market responds very favorably to an upturn in investor sentiment—or when policy risks moderate. But, when those two important barometers 'improve together,' stock results are amazingly strong," Paulsen said.
But gains still could be derailed by more macro headwinds, he noted, pointing to growing recession calls on Wall Street and concerns about corporate profitability, which other analysts have warned could bring more pain to stocks.
"Some of those apprehensions will most likely persist in the coming year. In our view, sluggish economic growth, recession prospects, and weak corporate-profit growth should continue to be of concern," Paulsen said.