Stock Market Selloffs Aren't Over Yet. Here Are 4 Reasons Why

The U.S. stock market staged a strong recovery on Tuesday, but further declines may be on the horizon. Several factors suggest that more selling pressure is likely in the coming weeks.

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One major concern is the increasing signs of U.S. economic weakness, which could heighten fears of a recession and drive stocks lower. Although investor sentiment has turned pessimistic, it hasn’t reached the extreme bearish levels typically associated with a contrarian buying opportunity.

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A key moment for the market may come on Friday, March 7, when the latest U.S. employment report is released. While this data could trigger additional volatility, there is little indication that a full-blown recession is imminent. As a result, a severe bear market—a decline of 20% or more—appears unlikely. Instead, a more typical correction of about 10% in the S&P 500 is a more plausible scenario.

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For investors navigating the current market environment, there are several important takeaways:

1. Those considering adding to their portfolios may find better entry points ahead if the market continues to weaken.
2. Long-term investors should avoid attempting to time the market by selling now and repurchasing later, as this strategy is notoriously difficult to execute successfully.
3. Investors with a long-term focus might want to increase their dollar-cost averaging during this period of market weakness, taking advantage of potential price dips over the next several weeks.

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Several indicators suggest that the market’s recent declines may not be over. Here are four key reasons why further weakness could lie ahead:

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1. Economic Growth Is Slowing

According to Jim Paulsen of Paulsen Perspectives, multiple factors are contributing to slower growth and rising recession fears. Paulsen, known for his accurate market predictions, previously warned of the current selloff due to these concerns.

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He points to several contractionary forces that are still at play, including elevated Treasury bond yields, a strong U.S. dollar, slow money supply growth, and rising inflation. These factors, he believes, will continue to weigh on economic momentum.

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Paulsen predicts that U.S. GDP growth will likely slow to around 2% or lower in 2025, which could intensify recession fears and further pressure the stock market. Historical data supports this view. A chart tracking the 10-year Treasury yield versus the Citibank Economic Surprise Index shows that as bond yields rise, economic surprises tend to fall, leading to increased recession concerns and market declines.

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The 10-year bond yield peaked at 4.8% in mid-January, and due to the typical three-month lag, this suggests economic momentum could continue to slow until at least April.

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2. U.S. Financial Conditions Are Weakening

Another troubling sign comes from the Bloomberg Financial Conditions Index, which monitors the health of the financial sector—a key driver of economic growth. This index has shown deteriorating conditions throughout the year.

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In 2023, similar weakness led to a 10% correction in the S&P 500 and a nearly 20% decline in major tech stocks, including the so-called "Magnificent Seven." The recent sharp downturn in financial conditions indicates that the full impact on the economy and stock market has yet to be reflected, implying that further downside is possible.

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3. Market Signals Point to Further Declines

The stock market often acts as a leading indicator for future economic trends. One way to assess market sentiment is by comparing the performance of consumer discretionary stocks—items people buy when confident—against consumer staples, which represent everyday essentials.

When consumer discretionary stocks underperform relative to staples, it signals a shift toward caution and typically precedes broader market declines. Recent data shows this ratio has fallen sharply, marking the second-largest one-month drop since 1990. Historically, such a decline suggests that further losses in the S&P 500 are likely.

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4. Sentiment Isn’t Bearish Enough for a Buy Signal

Contrarian investors often view extreme pessimism as a buying opportunity. However, current sentiment has not reached the levels typically associated with a market bottom.

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The American Association of Individual Investors (AAII) survey reflects rising bearish sentiment, but it hasn’t met the threshold of bearish investors outnumbering bullish ones by at least 10 percentage points for four consecutive weeks—a condition that often signals a buy opportunity.

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Further, Bank of America data reveals that institutional investors remain nearly fully invested, with cash holdings near record lows. This indicates that large-scale investors have not yet adopted the kind of defensive positioning that might suggest a market bottom is near.

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Why a Recession Is Unlikely

Despite these concerns, Paulsen does not foresee the U.S. slipping into a recession. He expects GDP growth to slow to around 2%, while the 10-year Treasury yield may fall closer to 3%. According to Paulsen, the primary reason a recession is unlikely is the relative health of the private sector. Unlike previous cycles, businesses and households have not overextended their balance sheets, reducing their vulnerability to economic shocks.

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, two key trends could support growth going forward: the U.S. dollar has weakened, and bond yields are beginning to decline. Both developments typically boost economic activity.

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Paulsen also anticipates that the Federal Reserve will shift toward easing monetary policy later this year in response to slowing growth. This move would help drive inflation toward the Fed’s 2% target and provide further support for the economy.

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In summary, while the market may face additional volatility and further declines in the near term, the broader economic outlook does not point to an imminent recession. Investors should remain patient and consider taking advantage of lower prices through a disciplined, long-term approach.

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