Stocks are in for a 20% rally through the rest of 2023 if they can clear three hurdles, Fundstrat's Tom Lee said.
Lee pointed to signs of falling inflation and improving market breadth that support his bull case.
He has made the case for months that a new bull market is emerging in stocks.
Stocks could rise in a sharp rally through the rest of 2023, if the market can clear three main hurdles, according to Fundstrat's head of research Tom Lee.
"As we move into the the second week of June, our confidence that [the] S&P 500 will gain >20% in 2023 has increased. The decisive upside breakout last week helps, as are signs that inflationary pressures are easing," he said in a note on Monday, pointing to the pullback in wage growth in the May jobs report.
Wages continued a modest slowdown last month, easing to a 4.3% yearly increase compared to the 4.4% yearly increase seen in April. That's a sign that inflation pressures could be abating in the economy, as higher wages can influence prices to move up as well.
Easing inflation pressures could signal upside in stocks, Lee said, as it would allow the Fed to pause or dial back interest rates hikes. Fed officials have raised rates aggressively over the past year to combat inflation, which weighed heavily on equities in 2022.
He pointed to three key indicators in stocks that could flash in the next month and cement the S&P 500's trajectory for the rest of the year:
1. The May Consumer Price Index Report
May inflation data will be critical into determining the path of stocks, Lee said. If core inflation clocks in below a 0.4% monthly increase or below a 5.5% yearly increase, that will boost the odds the Fed will pause its rate hikes, which is likely to spur a rally in stocks.
The May consumer price index report is slated to be released on June 13. But markets have already dialed back their inflation expectations significantly, with an estimate of five-year average inflation five years from now dropping to 2.25% over the last week, according to Federal Reserve data.
2. The AI-driven rally for tech stocks
Tech stocks have soared in 2023 as firms cash in on the AI hype and vow to implement more artificial intelligence technology into their businesses. There's a chance the Fed won't tolerate that enthusiasm, Lee said, given that some tech giants, like Tesla, have soared nearly 100% since the start of the year.
But AI could actually be easing inflationary pressures, since increasing productivity at work will suppress wage inflation in the long term, Lee added. That suggests the Fed won't tighten financial conditions to fight the tech rally, which means upside for the overall market and for tech stocks in particular.
3. Increasing market breadth
The percentage of winning stocks in the S&P 500 has increased significantly, with eight out of 11 sectors trading above their 20-day moving average. Six of those sectors have a 20-day moving average that's above the 200-day moving average, another sign a positive trend in the market is taking shape.
He also called the start of a new bull market in March of this year, and has predicted the S&P 500 would rise 24% in 2023 as the Fed pulls back on tightening, implying the benchmark index would retest an all-time high of around 4,800.
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