One of Wall Street's Most Bullish Strategists Is Growing Cautious About the Stock Market

Over the past three years, the bulls have won the day on Wall Street. The S&P 500 index still has a chance to register three consecutive years of at least 20% gains, something that has rarely occurred before. Some strategists and pundits think the party can continue, as the Federal Reserve has cut its benchmark interest rate at each of its last two meetings, and the labor market, though it may be slowing, is seemingly still on solid footing.

But there is another camp of strategists who believe a bubble has formed that could pop with ugly consequences. In the latest indication that conditions have perhaps gotten too frothy, one of Wall Street's most fervent bulls has started to grow cautious about the state of the stock market.

Too many bulls in the room

Many market watchers may have heard of Ed Yardeni of Yardeni Research because he has been one of the most bullish strategists in recent years. In fact, early this year, he said the S&P 500 index could hit 10,000 by 2029, which implies close to another 50% upside over the next four years.

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But in a recent interview with Bloomberg, Yardeni was more reserved and even outright cautious on the state of the stock market, which has risen by close to 15% this year (as of Nov. 6).

"There are too many bulls," Yardeni said, adding that the market rally may have gotten ahead of itself. "Just one unexpected event could knock stocks down from their highs amid poor market breadth, but that may be tough to do, given that traders are usually optimistic around the holidays."

One such event could be if the Federal Reserve fails to lower the federal funds rate at its final meeting of the year in December. The Fed cut interest rates by 0.25 percentage points (25 basis points) at each of its last two meetings.

Following the last Federal Open Market Committee meeting, Fed Chair Jerome Powell said that another cut in December was not a "foregone conclusion." While the experts' views on the odds of a December cut decreased drastically following Powell's comments, traders betting on the federal funds rate still see about a 65% chance of a cut. If those odds continue to drop, though, the stock market may slide as well.

Things have been more difficult for the Fed because of the government shutdown, which has resulted in several government agencies not publishing key economic data that the central bankers rely on to guide their fiscal policy moves.

If the government reopens and the latest inflation data comes in hotter, I certainly would not expect another interest rate cut this year, because the Fed won't want to create conditions that would drive inflation back upward. However, it is a delicate balance because the longer interest rates stay high, the more likely it is that the economy will tip into a recession.

Then there are questions over the artificial intelligence sector, where buoyant stock prices have provided much of the lift for the whole market in recent years. Investors are currently debating what inning the AI boom is in: Is the party still just beginning, or is the AI space in a bubble that's on course to pop?

You likely won't see it coming

Yardeni isn't outright bearish. When asked about his advice for investors, he said: "Buy the dips if you have cash.... But don't play games and sell anticipating a major drawdown. I don't see a major correction coming for the stock market beyond 10% anytime soon."

Timing the market successfully and reliably is an extraordinarily difficult task, and retail traders should refrain from trying to. Instead, be patient and play the long game. The longer one holds stocks, the less likely they are to lose money.

I also think that recessions and drawdowns are likely to be triggered by issues that most investors won't see coming. Now, I'm not saying that rising inflation or some event impacting the AI sector won't spook the market. However, for there to be a cataclysmic event that outright crushes the stock market, like when the dot-com bubble burst or the Great Recession struck, it usually is set off by a factor that surprises 99% of investors.

If the majority of the market could anticipate the big problems early, then investing would be much easier. With that in mind, retail investors should stick to the fundamentals and take a long-term investing approach.

Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.