Stocks are about to plunge, Wells Fargo warns

Gina Martin Adams is sticking to her guns.

The Wells Fargo strategist has been bearish on stocks all year, even as she watched the S&P 500 (^GSPC) add 21 percent. And on Thursday's " Futures Now ," Adams reiterated her call that the index would close out the year at 1,440.

"Our target is based on fundamentals," Adams insisted. "We're basing our target on typical valuation measures, given the level of interest rates and also on earnings forecasts. And that's why our target is relatively low."

In fact, "low" is somewhat of an understatement. Adams' target implies that the market will drop 16 percent in little more than three months, erasing everything that stocks gained after the year's first day of trading. This makes her one of the lone bears on the Street.

So what could produce such a dismal fourth quarter for stocks? First of all, Adams is highly skeptical about the rally that the market has enjoyed thus far.

"It's all about emotion at this point. The entirety of the S&P 500's increase this year has come via the multiple," Adams said. "It's been simply through the amount that investors are willing to bid up the value of the future earnings stream."

Indeed, the S&P 500's price-earnings multiple has risen from 17 on Jan. 1 to nearly 20. That means the market has largely been rising due to investors' willingness to pay more for those earnings.

Adams goes on to argue that the recent rise in Treasury yields could put an end to this inclination.

"The multiple is one of the most valuable components" of the rally, and "typical drivers of the multiple are interest rates." So despite the fact that yields have cooled off recently, "simply the fact that we moved from 1.6 [percent] on the 10-year Treasury rate to now the 2.7 [percent] range is a potential tremendous shock over the next six months," Adams contended.

Adams believes that stocks haven't yet digested the rate rally. "Stocks tend to follow rates over time," she said. "Typically, when you get a 100 basis point [or 1 percent] move in Treasury rates, you get a contraction on the P/E multiple on stocks of about a full turn. That, by itself, implies you get something of a 10-percent-plus correction in stocks."

And while the Fed's decision that it wouldn't slow its rate of asset purchases has driven the market to yet another all-time high this week, Adams doesn't believe the surprising announcement will ultimately make a difference.

"Unless bonds can actually rally substantially with the so-called Fed bid, and the Fed is able to manipulate yields significantly lower, the damage has been done, and I think the cat is quite frankly out of the bag."

Couple the rise in rates with slow earnings growth, and Adams believes the market is in for a very tricky fall.

"We're going to have to face the music come October," she said.


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