Stocks are getting a delta peak and growth slowdown wrong, market bull Jim Paulsen says

There may be a new reason to follow the smart money.

According to The Leuthold Group's Jim Paulsen, the stock and bond markets have been delivering opposing messages about the economic recovery's strength for months.

But he finds only one is continually right: bonds, which foreshadowed slower growth tied to Covid delta variant hot spots before stocks.

"It was a big collapse in July where the 10-year [Treasury note] yield went all the way down to almost 1.1%," the firm's chief investment strategist told CNBC's "Trading Nation" on Monday. "It was suggesting that Covid, the delta variant, was going to be a big problem for the economy."

Even though stocks are at or around record highs, Paulsen emphasizes many of the winners aren't tied to economically sensitive areas of the marketplace. The trend, according to Paulsen, suggests economic sluggishness and perhaps a further slowdown.

Meanwhile, Treasury yields are firming again — a signal that implies a rosier outlook for economic growth. The benchmark 10-year yield is around 1.26%.

"They haven't gone back down to rechallenge that 1.10% level," said Paulsen. "That's a pretty major bottom they put in, and they're kind of suggesting the Covid variant here is likely to roll over soon and economic activity is likely to pick up."

Paulsen, who oversees about $1 billion in assets under management, believes it's best to listen to the bond market.

"They fell long before the stock market did in early 2020. They bottomed before the stock market did in March 2020. They took off solidly in the summer to early this year," he noted. "And, they were the first to roll over again in the face of the second round of Covid here that we've experienced of late."

However, the longtime market bull acknowledges vulnerabilities exist.

"We're going to have a sort of higher anxieties again with inflation as we in the balance of this year, and overall I think inflation is going to stay hotter for longer," he said. "Inflation could scare us and maybe even lead to a correction at some point."

Paulsen speculates a stock market setback would be temporary and inflation would subside next year.

His top market plays are dominated by groups that benefit from the economic recovery. Paulsen particularly likes small caps, cyclicals and international markets.

"I really think that economic surprises which have been negative of late turn positive as Covid peaks out again," Paulsen said. "I'd stay diversified, but I'd tilt towards those areas of the market. I think it could be a nice run in the last four months of the year."

On Monday, the tech-heavy Nasdaq jumped 227.99 points to end at 14,942.65, a record close. The broader S&P 500 hit an intraday high.

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