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Wall St. bull Tom Lee sees 5 reasons why stocks extend their post-Brexit shock rally

Sam Ro
Managing Editor
Fundstrat's Tom Lee (Image: Bloomberg TV)

After the world learned that the UK voted to leave the European Union in the so-called Brexit vote, financial markets reacted violently sending stock tumbling. In just two trading sessions, the S&P 500 plunged an eye-popping 5.4%.

But as many market experts warned of the perils of this newfound uncertainty, a handful of pros told their clients something they didn't want to hear: buy stocks.

FundStrat Global Advisors' Tom Lee was among the Wall Street strategists telling clients to think opportunistically, saying that "we believe this pullback will ultimately need to be bought."

A week has gone by since the vote, and the stock market has nearly recovered all of its losses.

It's been a wild ride for the S&P 500.

So what's Lee saying now?

In a new 22-page research note to clients, Lee makes the case for the stock market rally to continue citing 5 bullish factors:

  1. The bull market has experienced worse things than Brexit. "Clearly, the UK will have some future relationship with EU (which model is not clear, Norway, Swiss, etc) and timing is unknown. In fact, timing arguably works in favor of “less bad” outcomes. But also…a 2% UK recession (peak to trough) subtracts $56b from global GDP. When crude fell to $26 ($42 drop from 2-yr avg), the negative drag on commodity producers was $1.6T annually. In other words, just a $1.60 change in oil is roughly the same GDP impact as a UK 2% recession."
  2. Political anxiety has come to a head. "Policyuncertainty.com shows that on 6/25, policy uncertainty surged to a 7-std deviation high (n=22 since 1985)… this has historically marked a low for equity markets—in other words, it’s a contrarian signal. The average 6m forward gain for S&P 500 is 12% (>5-std dev surge) with an 86% win-ratio. The only failure of this as a contrarian signal was 9/30/2008, when policy anxiety surged 7.5 std dev on TARP I failure."
  3. Big sell-offs lead big rallies. "Of the 50 instances when SPX tumbled, 16 took place when the index was above either its 50-day or 200-day moving avg (bull phase). On 6/23, the S&P 500 was above both its 50-day and 200-day, only 9 times previously (before a tumble). ...9 of 9 times, the S&P 500 rallied 3 months later with an avg gain of 7%. In other words, buy this tumble."
  4. Market volatility has collapsed. "...VIX fell 39% in the past 4 days, 3rd biggest since '91 and any decline >30% marks absolute bottom of sell-off...the S&P 500 has already established its bottom.
  5. Cash is waiting to enter the market. "There is a lot more cash on sidelines than the bears can appreciate—it only took 2 days to position square. Margin debt is still falling yoy, down 10% last month, and … every major market high has seen margin debt rise >40% yoy. In the meantime, the global search for carry brings investors to US assets every week."

Of course, it's no sure thing that the markets will continue to rally. Lee warns that there could be some systemic financial concerns being reflected in the sell-offs of Europe's biggest banks.

The idea of buying stocks after a big rebound in the face of all of this uncertainty is certainly an uncomfortable idea. But Lee would be the first one to tell you that some of the best investment decisions are the uncomfortable ones.

Sam Ro is managing editor at Yahoo Finance.

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