US stocks could take another dive, as 'FOMO' has led to a 'very abnormal' trading pattern, BTIG bull Julian Emanuel says

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US stocks could take another dive, as 'FOMO' has led to a 'very abnormal' trading pattern, BTIG bull Julian Emanuel says
Julian Emanuel, chief equity and derivatives strategist at BTIGCNBC
  • Markets are headed for a pullback for three reasons, BTIG's long-time bull Julian Emanuel said Monday.
  • "Rather than fear being priced in the options market, there's fear of missing out," he told CNBC's "Trading Nation". "That is a very abnormal position."
  • He said retail investor appetite, increasing volatility and a contested US election are all reasons for a correction.
  • He expects the S&P 500 index to correct up to 15% lower and the tech-heavy Nasdaq may fall up to 20%.
  • Visit Business Insider's homepage for more stories.
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US stocks could fall by as much as 20% from all-time highs, as various market-based indicators suggest that investors are still driven by "fear of missing out" and are far too optimistic, long-time bull Julian Emanuel, of financial services firm BTIG, told CNBC's "Trading Nation" Monday.

Emanuel, who is the company's chief equity and derivatives strategist, said there are three major reasons why the US stock market is looking ripe for a much deeper correction than the one over the past couple of weeks.

The first reason is an unusually large premium in extremely bullish derivative contracts over extremely bearish ones, reflecting the options-buying frenzy that was partly responsible for the run-up in the major stock indices to record highs this summer.

"Rather than fear being priced in the options market, there's fear of missing out. The price of out-of-the-money calls, as was the case throughout August, is still trading at a premium to the price of out-of-the-money puts," he said. "That is a very abnormal position."

These call options have strike prices that give their holder the right to buy at a price that is well above the current market levels, while the put options he referenced give the holder the right to lock in a selling price that is well below current rates.

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"That tells us that the public is still very committed — as are the large institutional investors," he added.

Investors are becoming more nervous

The second reason he gives is an increase in volatility. Wall Street's most widely used indicator of volatility, the VIX index, is routinely trading above the average level prior to the onset of the pandemic. Emanuel said the VIX has been trading in a range of 25 to 30 in the past few weeks, compared to an average of 15 to 20 before the pandemic began to roil markets in February.

With that in mind, Emanuel said the 12% drop in the Nasdaq that took place over the first two weeks in September, was a lot tamer than he would have expected, given where the VIX is currently trading.

And, given that the Nasdaq is still showing a 30% gain for the year to date, he said he expects to see a fall of another 15 to 20% from early September's all-time high at 12,074.06.

Emanuel said the S&P 500 could drop 10-15% from its record high of 3,588.11, as big-cap technology stocks such as Apple, which is up more than 130% in the last 12 months, will eventually lead the index lower. The S&P has gained around 4% so far in 2020, but more than 50% since hitting its lowest in over three years in mid-March.

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Emanuel's outlook for the S&P 500 index is similar to that of strategist Tim Hayes who thinks the index could fall by another 15-20% in the coming weeks before recovering.

Contested US election could cause a pullback

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Emanuel said uncertainty surrounding the US election will make stocks vulnerable to a correction that would be larger than what he called a "garden variety pullback". Investors are not yet positioned for a decisive win by either Democratic nominee Joe Biden or incumbent Republican president Donald Trump.

Read more: Paul Lambert returned 45% to investors in 2019 and is crushing the market again this year. The solo fund manager lays out his strategy for finding winning stocks - and shares 5 of his top picks today.

"Markets tend to be uncomfortable with uncertainty, it is clear the rhetoric is going to be nastier and the outcome is going to be more uncertain in the run-up to and perhaps through November 3," he said. "If you put that all together the odds are tilted in the favour of a further pullback," he concluded.

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