The S&P 500 exited the longest bear market since 1948 on Thursday, but the sizable rally that led it there may not last for long, according to one Wall Street veteran.
In an analyst note on Friday, Main Street Research founder and CIO James Demmert warned the stock market could resume its downward spiral soon.
"Even though the S&P 500 is up just over 20% from the October 2022 low, that does not mean the bear market is over yet," Demmert wrote. "The bear markets of 2000 and 2008 both saw rallies in excess of 20%, which did not constitute the end of the bear market, as the market experienced further downside after those rallies."
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Investors should be wary of the surging stock market because many stocks in the benchmark S&P index are still "firmly in the downtrends, which is the hallmark of a bear market," he said.
Mega-cap stocks – Nvidia, Apple, Microsoft, Amazon, Meta (Facebook), Alphabet (Google) and Tesla – have been the main driver behind the market's recent strength and its shift from bear to bull market.
That explains why the Nasdaq Composite and S&P are up so much more this year than the Dow Jones Industrial Average, which has a lower concentration of big tech stocks, according to the note.
Such narrow market leadership is "not a sign of a quality rally or bull market, and this phenomena leads to a market correction of some kind," Demmert said.
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"U.S. markets are overdue for a 10% correction, as the stock market at large is in overbought territory and investors are very complacent, which was the case prior to the past three major declines within this 18-month bear market," he added. "Investors should have some dry powder ready to go in the event of a near-term market correction."
In order to officially declare the start of a bull market, the majority of the stocks need to start establishing an upward trend.
Demmert anticipates this will happen in the second half of 2023.
The gloomy forecast comes after a brutal year for the stock market, its worst since the 2008 financial crisis. All three indexes tumbled in 2022, snapping a three-year win streak. The Dow Jones Industrial Average ended the year down 8.8%, the best of the three. The S&P 500 sank 19.4% while the tech-heavy Nasdaq Composite plunged 33.1%.
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Stocks rallied in the first half of 2023, and equities seem poised to continue that momentum despite sticky inflation, rising interest rates and the looming threat of a recession.
As of Friday morning, the S&P is up more than 12% from the start of the year.
