The stock market has endured a fast-and-furious selloff that's taken the S&P 500 down more than 10%, putting it in correction territory, something that's normally seen only about every year and a half.
It's been worse for the tech-heavy Nasdaq 100. Tech stocks were last year's darlings, and they've fallen more than average, especially those that enjoyed the best returns because of booming interest in artificial intelligence.
The drubbing has taken a stiff toll on many, given that most Wall Street analysts expected the S&P 500 to notch more gains this year following back-to-back returns exceeding 20%, including an impressive 24% return in 2024.
One fund manager who wasn't surprised by the sharp retreat this year is Doug Kass.
Kass has been professionally navigating the stock market since the 1970s, including a stint as research director for Leon Cooperman's Omega Advisors.
In December, he warned investors that stocks could retreat 15% to 20%, a message he repeated through February. His outlook puts him in the rarified category of those who correctly predicted the S&P 500's tumble.
This week, Kass revisited his outlook and made a major change. Given his track record and long experience in the market, paying attention to what he thinks could happen now may be savvy.
Hedge fund manager Doug Kass accurately predicted the S&P 500's decline in 2025.
The stock market faces a slate of stiff headwinds
My former mentor, who managed money in the 1970s, used to say, "Stocks go up; stocks go down." Sometimes, they go up and down more than anyone expects and for longer than some can remain solvent.
The key to surviving the markets long term is recognizing that returns don't happen in a straight line. Instead, they zig and zag. Sure, look at a long-term chart of the S&P 500, and it appears mostly straight-line 'up and to the right,' but if you zoom in, you'll see plenty of periods when stocks fell, like now.
And it's not as if the drop in the S&P 500 isn't without reason. In fact, stocks face multiple challenges that have contributed to the decline, including:
High stock market valuations
Concern about AI-spending growth
Worry about a slowing U.S. economy
Uncertainty about a bubbling trade war
The stock market entered 2025 arguably priced to perfection. The gains in stock prices last year were greater than earnings growth, and as a result the S&P 500's forward price-to-earnings multiple eclipsed 22 — far north of the 10-year average of 18, according to FactSet.
On the surface, valuation isn't a problem if everything goes right. Unfortunately, the market has a way of disappointing the masses, and a lot appears to be going wrong right now.
Much of last year's froth stemmed from significant interest in AI stocks benefiting from a massive move to train and operate large language models, or AI chatbots like OpenAI's ChatGPT, and agentic AI solutions, which can be used to perform business tasks.
Hyperscalers and enterprises have poured billions into refreshing network infrastructure, including servers and the semiconductors powering them to meet that demand. This gold rush of spending has catapulted AI-related stocks like Nvidia, whose graphics processing units, or GPUs, are best suited to the task.
While AI spending is expected to be strong again this year, there's concern that spending growth will stall, removing much of the AI tailwind. The fear was cemented by the successful launch of the Chinese AI chatbot DeepSeek, which was reportedly developed for only $6 million using prior-generation computers and chips.
The potential for the AI-spending spigot to shut off isn't the only negative market situation. Worries that we could experience stagflation, a period of slow economic growth and sticky inflation, have mounted this year.
Inflation isn't anywhere near what it was in 2022 when it eclipsed 8%, but progress toward the Federal Reserve's 2% target inflation rate appears to have stalled. According to the Consumer Price Index, inflation was 2.8% in February, up from 2.4% in September.
Inflation uncertainty is largely behind the Fed's decision to pause interest rate cuts. The Fed cut rates in September, November and December because inflation seemed under control. However, recent volatility led it to hold rates steady in January, and most expect it to remain sidelined when it makes its next rate decision on March 19.
The jobs market is also showing some concerning signs. Unemployment has increased to 4.1% from 3.5% as recently as 2023. In February, 172,000 people lost jobs. According to Challenger, Gray & Christmas, that's the worst reading in the month of February since 2009.
Let's not forget tariffs. President Donald Trump's policy plan focuses on convincing companies to move production back to America. As part of that plan, he instituted 25% tariffs on goods imported from Mexico and Canada and 20% tariffs on Chinese goods.
Those tariffs may encourage companies to restart shuttered manufacturing plants in America. Still, they'll also increase prices as most companies rely heavily on imports.
Affected companies will absorb some of the added expense, hurting profits, while costs passed on to consumers will hit already cash-strapped budgets.
Fund manager sees opportunity in the S&P 500's drop
Doug Kass is a self-described "contrarian with a calculator." He's happiest to be selling when everyone else is buying and buying when everyone else is selling.
That contrarian take was what drove him to his correctly bearish thesis in December. It's also behind his shift this week to opportunistically buy oversold stocks.
Kass started buying beaten-down stocks last week, picking up shares in Amazon and banks like Goldman Sachs. He has also actively sought exposure to the broader S&P 500 index, expecting a short-term oversold rally.
In posts this week, Kass outlined a series of reasons for his short-term shift from bearish to bullish in his diary in TheStreet Pro.
Largely, it comes down to a market that has fallen too far too fast.
In a conversation with me today, Kass said his view is for a "sawtooth pattern lower," suggesting we'll see multiple opportunities to buy and sell stocks at the lower and higher end of the pattern, respectively. He says that currently "we are at the lower end of the channel."
He also cites a low relative strength index. RSI is used to help determine overbought and oversold. Readings of 70 to 80 or higher are overbought, while readings below 30 are oversold. The S&P 500 RSI is currently 28.
Kass also pointed out that a 10% decline in the S&P 500 in 20 days is uncommon, and the current drop ranks fifth in the speed of its descent "in the past 75 years." Kass says that in the six similar periods, markets were higher in three, six or 12 months later.
Add to those tailwinds the fact that the volatility index, or VIX, and the put/call ratio, which shows bearish put buying relative to bullish call buying, are rising and the odds of markets putting in a short term low improve.
Of course, anything can happen. Kass is taking it slow, adding opportunistically on intraday drops in case stocks keep falling.
What did he do when stocks sold off on March 13?
"I have aggressively bought the whoosh," wrote Kass.
