Stock market could see ‘fireworks’ through the end of the year as headwinds have ‘flipped,’ Fundstrat’s Tom Lee says

In Lee’s view, 11 headwinds that this year helped drive the S&P 500 index to a 2022 low in October, including surging oil prices and the Federal Reserve’s hurry to lift interest rates higher to battle soaring inflation, “have all flipped.” On Monday morning, U.S. oil was trading at the lowest price of 2022 amid protests in China over the country’s strict rules aimed at curbing the spread of COVID-19, restrictions that investors fear will hurt consumption and economic growth.

Lee said he saw the easing of inflation in October, as measured by the consumer price index, as a “game changer” for markets, with the case for “a sustainable rally in equities” being the strongest that it’s been so far this year. Here are the 2022 headwinds that Lee sees becoming tailwinds.

Lee said that softer inflation seen in October appears “repeatable” and that the easing of price pressures should be “sufficient” for the Fed to slow its rapid pace of rate hikes, with December potentially being the last increase. Also, “if inflation is ‘as bad as 1980s’ I would have thought midterms would have been an incumbent massacre,” Lee said of the recent U.S. elections.

He said that other recent signals point to “a far different path forward for markets,” including “collapsing” volatility in the bond market and a relatively large decline in the U.S. dollar. Lee pointed to the plunge in the CBOE 20+ Year Treasury Bond ETF Volatility Index, saying he anticipated that a further decline would support the S&P 500 soaring to 4,400 to 4,500 by year-end. 

The S&P 500 ended Friday down 15.5% for the year, but up more than 12% from its 2022 closing low on Oct. 12, according to Dow Jones Market Data.

U.S. stocks traded lower on Monday, with the S&P 500
SPX,
-1.54%
down 0.8% at around 3,995, according to FactSet data. In the bond market, 10-year Treasury yields
TMUBMUSD10Y,
3.688%
were flat at 3.69% around midday Monday, while two-year yields
TMUBMUSD02Y,
4.434%
fell about five basis points to 4.43%. 

U.S. yields have recently seen a “massive decline ranking in the bottom 1% largest downside moves in the past 50-years,” said Lee. The odds are rising that 10-year and 2-year yields may be past their peaks, potentially supporting an expansion in price-to-earnings multiples in stocks, according to his note. 

“Skeptics will say “growth is the problem now” and point to downside” in the S&P 500’s earnings per share, or EPS, said Lee.  But the index historically has “bottomed 11-12 months before EPS troughs,” he said. “So EPS is lagging.”

Read: S&P 500 earnings estimates for 2023 take ‘complete U-turn’ as recession risks loom, according to BofA

Also see: Barclays says cash may be ‘real winner’ in 2023 while recommending bonds over stocks