Five Major Risks Converge in US Stocks; S&P 500 May Retrace 10% to 20% This Year

According to Marketwatch, recent consecutive weakness in US stocks may not be just normal market volatility. Market analysts warn that as seasonal selling pressure approaches, investor sentiment remains overheated, corporate earnings growth slows, and US economic momentum cools, the S&P 500 could retrace 10% to 20% before year-end. Technology stocks may even enter a bear market first.

However, analysts do not predict a full-blown US economic recession, nor do they recommend investors exit the market entirely. At this stage, it is more suitable to avoid chasing high prices, reduce leverage, and hold cash, waiting for potential investment opportunities that may emerge over the next two months.

Risk One: US Stocks Enter Seasonal Volatility Period

September has historically been the weakest month for US equities. According to Yardeni Research, since 1928, the S&P 500 has averaged a decline of about 1% in September. While this may seem modest, many significant market corrections have historically occurred during this month.

Although October’s average performance is slightly better, the annual low point for the S&P 500 often occurs around October 10–12. As US stocks enter a traditional high-volatility period, any negative news on the economy or corporate earnings could amplify downside moves.

Risk Two: Investor Sentiment and Market Indicators Are Overheated

Multiple indicators suggest market optimism has reached extreme levels.

The Investors Intelligence Bull-Bear Ratio recently rose to 3.88, nearing the warning threshold of 4. The Bank of America Bull & Bear Indicator reached 9.6 out of 10, triggering a contrarian sell signal under conditions of extreme bullishness.

When most investors are already positioned, there is less dry powder left to push prices higher. If negative catalysts emerge, overcrowded long positions could accelerate their retreat.

Former Wall Street strategist Jim Paulsen noted that the S&P 500 currently trades about 55% above its post-WWII long-term trend line—second only to the peak of the 2000 tech bubble. The index’s earnings per share (EPS) relative to its long-term trend is also at an extreme high, suggesting limited room for further substantial gains in both price and earnings.

Defensive stocks now account for only about 17% of the S&P 500’s total market cap, near historical lows, indicating investors are more fearful of missing out on rallies than protecting against downturns.

Risk Three: Wall Street Earnings Expectations Are Excessively Optimistic

Consensus EPS estimates for the S&P 500 over the next 12 months are nearly 90% higher than the actual average EPS over the past decade—far exceeding the roughly 32% premium seen since 1990.

Savita Subramanian, Head of US Equity and Quantitative Strategy at Bank of America, points out that excessively high long-term growth expectations typically correlate negatively with future stock returns. Historically, current earnings growth forecasts imply approximately a 7% downside risk for the S&P 500 over the next 12 months.

This does not mean corporate earnings are about to collapse, but rather that the market has already priced in abundant positive news. If actual earnings fail to meet these highly optimistic expectations, stock valuations could be revised downward.

Risk Four: The US Economy May Be Weakening

The US economy faces multiple downward pressures, including a strong dollar, rising oil prices, persistent inflation, a flattening yield curve, climbing 10-year Treasury yields, slowing money supply growth, and declining fiscal deficit as a percentage of GDP.

Paulsen notes that the impact of these factors on the economy typically lags by 6 to 12 months and may now be gradually reflecting in real economic data. The unexpected loss of 23,000 jobs in July could be an early sign of economic cooling.

Since market sentiment remains highly optimistic, investors may not have fully priced in the risk of economic weakening. If employment, consumer spending, or business activity deteriorate further, equity markets could undergo a more severe repricing.

Risk Five: Corporate Earnings Upgrade Momentum Is Slowing

Corporate earnings estimates are still being raised, but the pace of upgrades has weakened. Recent upward revisions to S&P 500 Q3 EPS estimates were about 0.89%, below the 1.16% seen after Q1 earnings reports.

Nick Raich, analyst at Earnings Scout, says the slowdown in earnings upgrade momentum is a noteworthy warning sign, though not yet sufficient to confirm the end of the bull market. Typically, two consecutive quarters of slowing earnings momentum combined with continued price increases are needed to form a clearer signal of a bull market top.

Therefore, the key going forward is not just whether corporate earnings continue to grow, but whether Wall Street continues to raise future earnings forecasts.

S&P 500 Could Retrace 10% to 20%

Paulsen estimates that US stocks could see a 10% to 20% correction by year-end, with S&P 500 tech stocks potentially entering a bear market. However, he does not expect a formal US recession, given relatively healthy household and corporate balance sheets.

A more likely scenario is a rapid rise in recession fears, leading to valuation contraction and tech stock selling pressure, without necessarily evolving into a prolonged bear market.

For investors, this does not mean liquidating long-term holdings. Timing exits and re-entries precisely is extremely difficult. For now, it is more appropriate to avoid chasing overextended stocks, reduce margin leverage, shorten profit-taking cycles in short-term trading, and gradually accumulate cash.

If US stocks do enter a correction phase, the next two months could still be viewed as a dip-buying window, especially around mid-October—a period historically prone to forming annual lows.