Sell Tech Stocks Now Before Bubble Bursts: Paulsen

Despite months of warnings, investors are still dangerously overweight in the biggest tech stocks, a scenario that worries Jim Paulsen, chief investment strategist at The Leuthold Group. As he told CNBC: "You wonder if we do hit an air pocket, if we would break below those February lows sometime this year, who do you think is going to sell? It's probably going to be those popular names because that's all anyone has recently bought." Indeed, he sees worrisome parallels with the dotcom bubble of the late 1990s: "I don't think it is nearly as severe as it was back then, but the culture is the same. The character is the same where everyone is going into the same, very narrow number of popular names."

Rising Risk in the S&P 500

Prominent among that "very narrow number of popular names" are the mega cap technology stocks known as the FAANG group. They have delivered price gains far in excess of the S&P 500 Index (SPX) as a whole in recent years. 

Source: Yahoo Finance; adjusted close data through June 20.

"More and more of the leadership stocks have been the more aggressive, high beta stocks," such as the FAANGs, Paulsen noted. As such fast-growing stocks have become a larger proportion of the capitalization-weighted index, he observed that "the S&P 500 has become half as defensive" during the current bull market. Specifically, he indicated that defensive stocks have dropped from 22% of the index in March 2009 to just 11% today.

Walter Price of Allianz Global Investors believes that the FAANGs have become so large that they face limits to further growth. Smart beta guru Rob Arnott of Research Associates cites history indicating that today's market leaders are likely to underperform over the next decade. (For more, see also: Why The FAANGs' Hot Streak May End Soon.)

Headed Down

Paulsen gave 50-50 odds that the S&P 500 will drop 15% from its current level. Such a decline would push stocks in the index back to about 2,352, a level it last tested during intraday trading more than a year ago, on May 18, 2017. But Paulsen is relatively optimistic compared to other well-known prognosticators who have called for stock market plunges of up to 50%. Among these bears are emerging markets fund manager Mark Mobius and former OMB Director David Stockman. (For more, see also: 'Daredevil' Stock Market Poised to Drop 40%: Stockman.)

Invest Defensively

Paulsen advised investors who are overweight in big tech stocks to take some profits, but he did not suggest that they should sell all, or even most, of their tech positions. He also did not indicate that investors should reduce their overall equity allocations. Instead, he recommended rotating portfolios toward more defensive stocks, saying, "Maybe buy a beat-up consumer staple or a utility or a pharma stock today that no one's taking a look at, but sells at a lot better value."

Long-time tech bull Paul Meeks also is among those who have turned bearish on the sector due to high valuations. By contrast, he sees value in bank stocks. (For more, see also: Tech Bull Meeks Shuns Sector, Buys Banks Instead.)