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The real reason the market sold off: ‘We were long overdue,’ strategist explains

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The Leuthold Group Chief Investment Strategist Jim Paulsen joins Yahoo Finance Live to discuss the market and what investors should look out for this week.

Video Transcript

- We want to bring into the stream to talk about what the next step is for a lot of investors Jim Paulsen, the Leuthold Group Chief Investment Strategist. It's good to have you here, Jim. And you've pointed out that you think a lot of the emotional selling is probably over. Quote, the market again has both buyers and sellers.

I want to ask you, who's got the power in this market? Is it the retail investors? Or is it more of the larger houses and institutional investors? Simply, I ask that because I've heard the term today the revenge of the retail investor, what we saw yesterday.

JIM PAULSEN: Well, I think it's hard to know for sure, Adam, who's really in control. I still think that overall of it, that institutions probably swing a little more power than the retail community does, although particularly in emotional sell offs like we've had, a lot of times retailers are a big part of that.

And I guess I think that what ultimately, when a correction or a bear market for that matter does end, it's not generally buyers which bring it back. It's most often just people, people that wanted to sell or are done selling. And they're all prepared for worse.

And then once the selling suspends, it only takes marginal buyers, very small buyers for that matter, that can move it quite a bit when all the sell side is done. And that's often how these crises, sort of emotional crises, end, is more about a lack of selling or the suspension of selling, as opposed to a bunch of new buyers coming into the market.

- Jim, this is Emily here. What do you think was the catalyst for this emotional selling? Because many of the factors that we've been talking about, including Fed rate hikes and tightening inflation and slowing earnings growth, have been known or at least expected for weeks, if not months now.

JIM PAULSEN: Yeah, I think it's a good question, Emily. I really think that the biggest catalyst for this correction is just that it was long overdue. And whenever a correction happens, we'll all have a ton of explanations for why. Whatever the things are of the day, we'll throw that in the pot, and that's why it went down.

But I think at some point, market corrections just happened because they're overdue. We typically, I think, since 1952, we've had 25 corrections and 10 bear markets. It's not uncommon at all to have at least one a year. And so at some point, we were long overdue from the start of this bull market, at least in the S&P 500, to get one.

And then, of course, there's always the reasons why. The Fed's got tight. We got inflation. We've got rising yields. We get Omicron slowing growth, all good reasons, but in reality I think it would this correction would have found itself with whatever the reasons were of the day.

So at the end of the day, I think we had to flush it out. We do a lot of good things. We gut check our sentiment. We kill off exuberance. We bring down valuations. We reduce the concentration of leadership, only in new era tech, a lot of good things. Now yields have come off again. Maybe the Fed's going to slow it to its tightening trajectory, all things which could help revive us.

- Jim, let's talk about the correction because I think a lot of us recall six, seven, eight months ago, we're being told before the end of 2021, there's going to be a pullback. That was a big talk during the summer. It didn't come. So here we have correction. But you point out, look, the forward one year payoff can be pretty good if you stay the course. Help investors who might be upset with the volatility of the last two days understand what the next 12 months looks like.

JIM PAULSEN: Yeah, I think that's the main thing to focus on. These emotional sell offs that are so severe and they happen so quickly, they are as tough for the brand new 20 something investors as they are for us old crusty investors that have been around for almost 40 years in this business. They don't get any easier. They scare you to death. And that's what they need to do. And they do that very well.

But I think a lot of times when we get into this, you ask yourself one question. Is this the end of the bull market? Is this the end of the economic recovery? And for me, the answer there is no. The fundamentals under this economy remain very strong. I think we're going to grow close to 4.5% this year. And earnings results remain very good overall. And I think they're going to win out.

So this looks much more like a correction than a bear market. Of the 25 corrections we've had since 1952, when you look at what it does once the correction finally bottoms, from the low of the correction, what does the stock market do on average over the next 12 months? And what you find out is that on average in the next 12 months, after the previous 25 corrections, it was up on average a little more than 24% in the next year.

And we went into this correction with very low consumer confidence. And when that has occurred, from the lowest levels of consumer confidence, we've had even larger one year forward returns, almost 33% one year forward returns. So I think when you're worried about how much you're losing, you ought to think about if I just hang in there, how will I feel 12 months from now? And typically, traditionally, you're going to feel pretty good if you stay the course.