How to Take Advantage of the Coming Market Surge

When the economy drops as much as it has, history shows a powerful stock bull run is forming, says Leuthold’s Paulsen.

Could be, with apologies to Bachman–Turner Overdrive, you ain’t seen nothing yet. The stock rally since the pandemic-induced low of March 23, is up 61%. Year to date, the S&P 500 has advanced 11.7%.

But more is on the way, according to Jim Paulsen, chief investment strategist at the Leuthold Group. When the economy has slid as much as ours has, another big market jump will result, once the economy repairs the damage. A lot of bullish forecasts are kicking around, including from Goldman Sachs, but Paulsen’s takes the prize.

How big will the market advance be? An annual 24.5%, based on patterns since 1950, Paulsen told CNBC. Just when that would begin is a little murky, but presumably it kicks in once the economy has improved more than it has now.

While the economy has indeed pulled itself out of the doldrums, and good vaccine news has helped, what Paulsen refers to as the “output gap” still is lousy. That’s the difference between where actual gross domestic product (GDP) is and what it could be, if there was full unemployment and productivity had returned to its pre-recession pace.

At the moment, he indicated, the gap is 8%—an improvement over the wretched 11% reading last spring, yet still worse than the post-war nadirs of yore.

GDP plunged in the second quarter and began struggling back in the third. Unemployment has shrunk to 6.9% from its 14.7% peak in April. Yet, even still, the pandemic, he said, “created the biggest divot in the economy that we’ve ever had in the postwar era.”

Idle economic power eventually will get things revving again, he reasoned. “When you have this much excess capacity on Main Street, high levels of labor and capital and land unemployment, there is no way we’re going to sit here and accept that,” Paulsen said.

And then, investors will really, really have a yen for risk assets, he predicted. Namely, stocks. The tragedy that COVID-19 has imposed on humanity has one bright side, he went on. The situation has “created a very unique opportunity for investors to be able to invest in an environment which historically has been super good for the stock market.”  

How best to navigate this terrain? Small cap stocks and cyclical sectors will do well, he said, but avoid dividend yield and momentum stocks. The outlook for value versus growth is mixed, he added.

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