This contrarian factor suggests stocks could hit all-time highs

It’s shaping up to be a milestone month for stocks.

The S&P 500 is on track to see its best January performance in 30 years, and long-time bull Jim Paulsen believes there’s no reason to second-guess the rally.

He points to a contrarian indicator: pessimism — a factor that’s still playing a major role on Wall Street.

“We’re going to get more weaker economic and earnings news here over most of this year. But I think where people are at, they’re almost fearing more than that,” the Leuthold Group chief investment strategist said Wednesday on CNBC’s “Trading Nation.” “People are still fearing recession a lot.”

According to Paulsen, optimism will replace recession worries because expectations are set too low. He predicts that once investors realize it’s a slowdown scenario, stocks will surge even higher this year. He calls the current phase a “fearful period” that will ultimately refresh market valuations.

“The slowdown, when it becomes recognized as such, [often] leads to another big market rally — as valuations come back up, and the Fed actually stops tightening and may even become accommodative,” he said. “It happened in the ’80s a couple of different times. It happened in the ’90s where we had big market moves during an economic slowdown and after a period of overheat.”

Paulsen characterizes overheating pressures such as Federal Reserve’s tightening policy and inflation as a 2018 story.

He expects Fed officials will rescue Wall Street this time, too, by putting its interest rate hike plans on pause. Paulsen expects the move to create an ideal environment for gains. In fact, the Fed took such a tact on Wednesday.

Even if stocks see another pullback that retests the Dec. 24 lows, Paulsen sees a strong possibility the S&P 500 will surpass its all-time highs. His 2019 target on the index is 2,900 to 3,000, an 8 to 11 percent increase from current levels.

The S&P 500’s record high is 2,940.