A top analyst explains why your 401(k) is protected from a 40% stock market decline, but not from a 10% to 15% correction.

One of Wall Street's most seasoned strategists has indicated that although a significant market downturn is unavoidable, the danger to broadly diversified retirement portfolios is considerably less severe. Michael Cembalest, who chairs market and investment strategy at J.P. Morgan Asset and Wealth Management, shared his balanced perspective with Galloway and Elson, recognizing the market's exceptionally high valuations presently but doubting a devastating 40% decline.

Cembalest invoked the financial metric known as “Dr. Doom” to illustrate how stock market bears issue warnings during market corrections: “As soon as any asset falls by 10%, Nouriel Roubini and the rest of the [bearish] people come out of the woodwork and say, ‘Okay, this is it, this is the big one. Everything’s going to go down from here.’”

Coins2Day has reported on comparable warnings, with concerns about an AI bubble being raised by the likes of self-proclaimed “perma-bear” Albert Edwards and the highly popular Irish financial podcaster David McWilliams. However, Cembalest noted that a market correction doesn't always result in a significant downturn.

He also shared his thoughts on Damodaran's pessimistic outlook, noting that Damodaran had cautioned that all assets were overpriced and that a 40% drop in the Magnificent 10 would trigger widespread market panic. Damodaran even advised investors to shift substantial parts of their holdings into cash or collectibles. While showing respect, Cembalest pointed out a distinction between the perspective of a finance professor and that of active market participants.

“You know, professors are basically running fantasy baseball teams by coming out intermittently and telling you what their trades are. It’s not real money. It’s not real life,” he quipped.

The J.P. Morgan analyst concurred that the market hinges significantly on exceptional forecasts, yet Cembalest contended that the present AI expansion doesn't possess the systemic dangers seen in prior speculative manias.

Why a 40% crash is unlikely

In his view, the crucial difference lies in financing: Previous capital spending booms, such as in fiber-optics or gas turbines, were primarily financed with debt, making them vulnerable to a sudden, systemic “unplug” by the debt markets. Today, the massive capital spending fueling the AI revolution is largely being financed with internally generated cash flow, not debt, with the notable exception of Oracle, he said.

“That simply means it can go on for longer before it gets unplugged by the debt markets,” Cembalest noted, explaining that this dynamic “doesn’t relieve you of the ultimate need for there to be substantial profit generation,” but it does mitigate the risk of a sudden seizure in the financial system. This reduced systemic debt exposure suggests that the market will not “unravel into the big 40% corrections that we had in 2009” and then again in 2001, he added.

Cembalest's primary projection for the coming years anticipates a probable, less severe correction rather than a 40% downturn. He noted that assets frequently experience corrections when they reach 20- to 25-year peaks, though these adjustments typically involve smaller percentage drops. “It would be kind of shocking if you didn’t have some kind of profit-taking correction in 2026 at some point on the order of 10% to 15%.”

Implications for the typical investor

Cembalest advised that the extent of the downturn necessitates readiness rather than alarm for typical investors or 401(k) participants. He pointed out that his company's standard balanced and conservative investment portfolios are already quite cautious, maintaining 30% to 40% in a mix of cash, cash equivalents, gold, diversified hedge funds, and short-term assets.

Jeffrey Gundlach, the renowned "bond king" and founder/CEO of DoubleLine Capital, told Galloway and Elson in a previous episode that gold was his “number one best idea for the year”, suggesting it should constitute 25% of an investment portfolio. He later revised this recommendation to 15% once gold's price appeared to stabilize near $4,000 per ounce.

Cembalest suggested that individual investors could employ comparable defensive tactics. Instead of making significant adjustments to their investment portfolios, he indicated he was guiding clients toward shifting from growth-oriented holdings to more moderate or balanced options, thereby matching their comfort with risk to the present elevated market values.

Furthermore, individual investors have the flexibility to act quickly during market turmoil, which institutional funds often lack. Cembalest recommends that investors begin accumulating “dry powder” now to take advantage of opportunities. Since corrections often tend to be “very V-shaped,” with a rapid, violent unwinding of risk followed by a quick snapback, having spare cash available allows investors to buy assets when they temporarily sell off.

Cembalest recognized the substantial investment in AI, comparable to the combined expenditures of the Manhattan Project, Hoover Dam, and Apollo program relative to GDP, yet he determined that a 12% to 15% market downturn is presently more probable than a 40% severe decline.

However, as Elson pointed out in the podcast's opening, such a correction would still have a major impact on countless investors and the broader economy: Cembalest's primary projection is “kind of a big deal in and of itself.”