The stock market is likely headed for a correction, but it won't be the start of a bear market, research firm says

• Ned Davis Research said soaring stock market optimism makes a correction look likely.
• Major stock indexes are hitting record highs, and that's created a "sugar high" among investors.
• Still, NDR said the conditions for a bear market won't be in place even if a correction hits.

Widespread investor optimism has fueled record after record across global stock markets this year, and Ned Davis Research forecasts a correction could be looming even as conditions for a bear market remain insufficient. 

In a recent note, Tim Hayes, the firm's chief global strategist, explained that wider market breadth has made new highs the new normal rather than the exception. While burgeoning enthusiasm isn't necessarily negative, the longer it lasts, the more markets are vulnerable to earnings let-downs and a potential correction. 

To that point, major indexes across the US, Japan, France, Australia, Taiwan, and others have all soared this year. For the first time in roughly three years, nearly a third of the 47 All Country World Index markets are within 5% of record highs, according to NDR. 

"The abundance of new highs has produced a sugar high among investors as paper profits have accumulated," Hayes wrote.

He pointed to the DSI Global Sentiment Composite, depicted below, which touched 84% to start the month of March — the highest level in nearly a year.

The equal-weighted ACWI is hovering at its highest level since early 2022. In addition, the share of MSCI World Index stocks within 5% of records has reached similar levels. 

When the excessive optimism wanes and the sentiment composite dips into neutral mode from a level above 70%, Hayes said, the MSCI ACWI tends to decline. 

"[W]ith the one-year and four-year cycles becoming less favorable, a correction can be expected," Hayes wrote.

In NDR's view, 2024 should see one or more corrections, though any moves lower are unlikely to be as severe as the declines of 2020 or 2022, which were driven by recession, inflation, and interest rate concerns.

"We don't expect a bear market any time soon," Hayes maintained. "The macro outlook lacks sufficient evidence to expect the return of crippling inflationary pressures or enough economic weakness to make a global recession an increased probability."

Indeed, it was only a year ago that the Wall Street consensus was for an economic and market downturn. With inflation broadly cooling over recent months and AI hype powering the stock market, many forecasters at the top banks have since pivoted toward soft-landing and bull-market outlooks.