A veteran strategist is urging investors to guard against a stock market correction caused by a risk as dangerous and obvious as an 800-pound gorilla.
Scott Wren, a senior global market strategist at Wells Fargo Investment Institute, recently noted that market breadth is abnormally narrow. He found that the five best performers in the S&P 500 accounted for nearly three-fifths of its exceptional 10.6% year-to-date gain through May 31. The index’s handful of mega-cap growth leaders rose 40.8%, while the others weren’t even up 5%.
“Let’s address the 800-pound gorilla in the room: the small number of stocks that are contributing the bulk of the SPX return this year,” Wren wrote in a June 20 note. He added: “Clearly, the rally this year has been very narrow.”
Top-heavy markets can rise for weeks or months, though Wren cautioned in a recent interview that those gains eventually become unsustainable.
“Historically, if you look over a large number of cycles, when market breadth gets really narrow and the market’s going up, it takes you to a meaningful top,” Wren told Business Insider.
Fellow strategist Steve Sosnick of Interactive Brokers likened investors’ shift toward mega-cap tech to “playing Jenga with the stock market” in a June 20 note. When breadth is weak, Sosnick wrote, the market — just like the tower in the wooden block game — “becomes increasingly top-heavy and unstable as parts of its foundation are used to make it rise.”
As anyone who’s played Jenga can attest, moving higher without a solid foundation soon leads to a crash as large and loud as the rise. That fate will soon apply to the S&P 500, Wren warned.
“This trend’s going to go, until it doesn’t,” Wren said. “And when it breaks down — and at some point, it will — it’s probably going to happen pretty fast. And so we want our clients ready for that.”
Stocks have substantial downside in a weaker economy
History teaches that narrow market rallies end with downturns that are “well in excess” of 10%, Wren said. Such a sell-off would take the S&P 500 below 5,000 for the first time since April.
“You could expect, certainly, a 10% pullback,” Wren said. “That’s not a bold call, given the run that we’ve had.”
While Wren is calling for a sizable slide, he remains optimistic about US stocks in the medium term. That’s largely because the stocks leading the market are highly profitable, unlike in the tech bubble. He doesn’t expect the bull market that’s been in place since October 2022 to end, which indicates that a 20% downturn is a long shot. A 30% pullback is even less likely, he said.
Wren’s mild cautiousness is reflected in his firm’s year-end S&P 500 target of 5,200, which is about 5% lower than current levels. And Wells Fargo Investment Institute’s year-end target for 2025 is 5,700, which implies that the index will rise in the next 18 months, but only by 4%.
Stocks’ path of least resistance may be higher for now, but when the rally does pause in this momentum-driven market, the ensuing sell-off could be swift. Wren pegged the S&P 500’s 200-day moving average of about 4,840 as a logical downside target in the near term.
As for when the pullback is coming, the global strategist is watching for it this summer but said he doesn’t have a great feel for the timing. Stocks have shown they can stay afloat, despite narrow market breadth and elevated valuations. Wren is now watching for signs of euphoria.
“When retail investors are all in and they’ve got fear of missing out, that’s when they’re just jumping in,” Wren said. “That’s the top typically, and we’re not there.”
Besides narrow market leadership, Wren is concerned about slowing economic growth. He doesn’t expect a recession but believes US GDP will stay below 2% in the next few quarters as consumer spending and the labor market weaken. That won’t help market breadth, he noted.
Earnings growth may also fall flat, as analysts at Wells Fargo Investment Institute are calling for $260 worth of S&P 500 earnings in 2025 compared to the consensus estimate of $280.
“We don’t think that’s going to pan out,” Wren said of earnings estimates. “And so I think less consumer spending, the slower economy, earnings estimates that don’t pan out — those are likely to at least cause a decent correction, which we’re looking at as a buying opportunity.”
5 ways to invest ahead of a correction
While Wren acknowledged that he thought a downturn would have already brought him a better entry point into markets, he’s holding out hope that stocks will come back to him.
“We’re trying to be patient here,” Wren said. “And it’s tough to be patient when the S&P 500 set a bunch of all-time high records.”
Although US stocks broadly are richly valued, especially high-flying names in technology and communication services, Wren is bullish about stocks that can be under-the-radar AI winners in sectors like industrials and materials, as well as energy and healthcare companies.
The artificial intelligence trade has been all the rage in markets since early 2023, but as Goldman Sachs strategists recently pointed out, tech stocks aren’t the only way to play it.
Instead of paying up for Nvidia after its massive rally, Wren would rather ride its success indirectly by investing in companies building out data centers or providing their raw materials. It’s still unclear which firms will emerge as the biggest winners from the AI boom, Wren said, and many of today’s leaders will inevitably go the way of Pets.com.
“There’s probably some individual stocks that are a bubble, but what I would not call a bubble is the sectors like industrials and materials, where the companies [are] that are going to be building all these things, all this infrastructure,” Wren said.
Wren’s preference for those economically sensitive sectors may be surprising since he expects GDP growth to slow significantly. He’s confident that the infrastructure buildouts for AI and the US more broadly will keep them afloat. As for energy’s catalyst, Wren said oil will stay above $70 per barrel since supply is still limited.
Investors worried about a selloff can shift toward healthcare — a defensive sector that’s lagged the market this year but still has a solid long-term outlook as the global population ages. He’s less interested in utilities, a defensive group with AI exposure that has already had a strong run.
Outside stocks, Wren is also optimistic about short-term fixed income. This safe haven hasn’t paid off this year, he acknowledged, though he has locked in better yields and is ready to do so again if the group stays weak. Once interest rates fall, short-term bonds should take off.
“We think we’re going to have an opportunity not just to buy equities at lower levels but also to lock in some longer-term bonds,” Wren said.
