'We could have another 10% fall, easily,' El-Erian warns after big sell-off

VIDEO5:5905:59Mohamed El-Erian: We'll see investors DNA in the next few daysClosing Bell

Wall Street could be headed for correction territory if there is a shift in investor attitude, Allianz's chief economist Mohamed El-Erian said after the biggest market decline in months.

Investors have taken a liquidity approach to the market and buying the dips, thanks to stimulus action from the Federal Reserve. That mindset will be tested in the coming days as market fundamentals come into play, he said in an interview on CNBC.

"That is the tug of war that's going to play out, and it's going to show the DNA of investors," the chief economic advisor said on "Closing Bell" after major indexes recorded their worst sessions since June.

The Nasdaq Composite, which has rallied hard over the weeks, tumbled nearly 5% on Thursday as high-flying tech stocks took a breather. The S&P 500 and Dow Jones also suffered big losses, dropping 3.5% and 2.8%, respectively.

If a mindset shift is looming, El-Erian suggests market players should look out below.

"We could have another 10% fall, easily ... if people start thinking fundamentals," El-Erian predicted.

"If the mindset changes from technicals to fundamentals then this market has further to go," he added, "but it remains to be seen whether it will change."

The sell-off came despite a new weekly unemployment number that was better than expected, a sign that the labor market could be improving. About 881,000 claims were submitted last week, which was better than the 950,000 level that economists forecast.

El-Erian said the market, though, remains decoupled from not only the U.S. economy, but the VIX, treasury and high-yield markets at current levels. With the tech-heavy Nasdaq up double digits and the benchmark index up nearly 7%, the market was ripe for a pullback after five straight months of gains and the strongest August in decades, he said.

Should the market be judged by fundamentals, investors will be forced to take into account the precarious state of the economy as corporate bankruptcies still loom. He warned almost a month ago that large-scale bankruptcies could doom the market's rally from its pandemic-induced lows in the first half of 2020.

"If you are in a liquidity-based paradigm, you will be dominated by relative thinking, and that's where we've been. If you're in a fundamentally-based paradigm," he said in Thursday's interview, "the answer is: no, you are not paying for an economy that faces not just moderation in the way of improvement, but a rising level of bankruptcies."