Next week is critical for the stock market as investors brace for CPI data and a Federal Reserve meeting.
Fundstrat’s Tom Lee said low inflation could boost equities as it would reinforce a Fed pause in interest rate hikes.
“Our view remains that inflation is below consensus,” Lee said.
Next week is one of the most critical weeks for the stock market this year as investors brace for a Federal Reserve interest rate decision that could bring a pause in rate hikes and news CPI inflation data.
Fundstrat head of research Tom Lee said that as stocks enter a new bullish regime, the market could be rocked by volatility depending on how the new inflation data deteriorates. and the Fed’s reaction to this data at its June 13-14 policy meeting.
While the market consensus expects the core month-over-month inflation gauge to be 0.4% for the month of May, investors would be surprised if inflation moves closer to 0.3%. This would be a welcome surprise as it would reinforce the Fed’s potential decision to suspend interest rate hikes this month and in July.
“If the core CPI can [is less than] 0.4%, then we see these odds [of interest rate hikes] falling to zero for each month,” Lee said in a Friday note.
Lee is confident that inflation is indeed below the consensus based on real-time measures of the CPI, and that inflation is actually approaching the Fed’s long-term 2% target.
“If that happens, the Fed pause will turn into a data-driven mode, where the bar is raised for more. [interest rate] upside,” Lee said. “We expect investors to see this as a green light for risky assets, which means equity investors won’t fight the Fed.”
But if the Fed goes ahead with another interest rate hike, investors should be ready to buy a likely drop in stocks, according to Lee.
“Even if the Fed raises rates a few more times in 2023, for us the key is whether that’s in response to mounting inflationary pressures. And we believe those pressures are easing,” Lee said.
The bullish case for Lee is bolstered by the fact that the breadth of the market is beginning to expand, which is a healthy sign for the sustainability of the current rally. In other words, more and more stocks are starting to participate on the upside, rather than the rally being fueled by just a handful of mega-cap tech stocks.
“The breadth of the market is improving dramatically,” Lee said, pointing to the outperformance of small-cap stocks this week. “I still want to buy dips as the market breadth expands.”
Lee continues to recommend investors stay overweight in industrials and regional banks, and he reiterated his 2023 year-end S&P 500 price target of 4,750, representing 10% upside potential. % from current levels.
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