I am turning more cautious, winding down leverage, and letting cash build up in my accounts.
The reason: Spooky season lies just around the corner. September and October are typically the weakest months of the year. We also often see weakness in July and August, perhaps as investors get nervous about those looming difficult months.
Several factors suggest the market is vulnerable to a pullback. Here is a roundup.
Insiders
Insiders are no longer very active buyers. Insider buying for the week ending July 4 came in at just $12.7 million. Even accounting for the holiday-shortened week and earnings season restrictions, that is a very sharp decline from the 2026 pre-war weekly average of around $86 million. Insiders are not showing much interest in this market.
Note that my numbers exclude buying by beneficial owners, investors who report as insiders because they own large positions. I exclude them because they are not true insiders, and the majority of investors typically underperform the market.
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Signs of Trouble in Sentiment Land
A growing number of signs suggest sentiment may be getting too elevated, which would be a negative in the contrarian sense. Jim Paulsen of Paulsen Perspectives on Substack has done a good job of rounding them up. Here is a summary.
Defensiveness in the U.S. stock market has seemingly gone AWOL, says Paulsen. “Most investors are still more worried about ‘missing out’ on the next leg of this New Era bull run, now supposedly led by AI stocks, then they are about suffering any major stock market setback.”
For example, S&P 500 defensive stock market capitalization has fallen to 17% of the total S&P 500 market cap. That is close to a record low. Another good measure of risk aversion is the relative performance of “safer” low-beta stocks compared to high-beta stocks. This was recently at its lowest level since 1970. “Major lows in this relative total return index have historically proved to be times when investors should be cautious,” says Paulsen.
Wall Street company analysts seem pretty exuberant. Stock market bulls like to argue that recent stock gains are justified by earnings growth momentum, which has indeed been robust. However, a lot of gains in any market are based in expected earnings growth, as well. Here, we see signs of extreme bullishness, which might be a negative in the contrarian sense.
The 12-month forward consensus S&P 500 earnings per share (EPS) estimate is nearly 90% above the trailing 10-year average reported EPS, notes Paulsen. This is the largest premium since at least 1990. On average, the premium since 1990 is only 32%. “Investors cannot be wholly comfortable about continuing to buy the stock market today simply because estimated EPS remain strong,” says Paulsen.
“Historically, lofty long-term growth expectations have been a bearish setup, negatively correlated with future equity returns,” agrees Savita Subramanian, the head of U.S. Equity & Quantitative Strategy at Bank of America. B of A says history suggests the current long-term growth forecast suggests 7% downside risk for the S&P 500 over the next 12 months.
The broader market is outperforming tech. This could be a warning that New Era AI leadership is ending, says Paulsen. A similar leadership shift in 1999 preceded the underperformance of tech stocks. “In 1999, once the broad index started outperforming, the S&P 500 rally began moving sideways and eventually began declining in late 2000. The ‘tell’ might have been that leadership was starting to change in 1999 toward broader market plays,” he says.
The S&P 500 is trading far above its trendline, which might spell trouble. It recently traded nearly 60% above its historic trendline average. Since 1945, the divergence was only that great near the top of the dotcom market in the late 1990s “and that didn’t end well,” notes Paulsen.
The economy may surprise to the downside. Few economists are predicting a recession in the near term. This is reassuring, since typically recessions are what cause bear market pullbacks of 20% or more.
However, there are reasons for concern. One is the sluggish 0.5% annual labor force growth economists project for the next five years, says Paulsen. History shows that 0.5% labor supply growth supports real annual GDP growth of just 1.5%, on average.
Another problem is the recent flattening of the yield curve, which normally foreshadows a decline in overall EPS growth. Lower fiscal spending, slower real money supply growth, a stronger U.S. dollar, and higher bond yields also suppress growth.
Also problematic: First-quarter GDP growth mainly happened in the public sector (4.36% annualized gains) vs. the private sector (only 1.09% annualized gains). Historically, when a larger portion of U.S. economic growth comes from the public sector rather than the private sector, the stock market has usually struggled, notes Paulsen.
All of this suggests incoming data may show enough economic weakness to surprise investors, sparking a sell-off. “My guess is any pullback may prove to be a larger 10% to 20% correction, making it worthwhile to adjust portfolios a bit more conservatively for the coming months,” concludes Paulsen.
For more big-picture market commentary like this and a short list of the stocks that smart insiders favor the most, consider subscribing to Cabot Insider Edge.
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