Next week is critical for the stock market as investors brace for CPI data and a Federal Reserve meeting.
Fundstrat’s Tom Lee said a low inflation reading could boost stocks as it would bolster a Fed pause in interest rate hikes.
“Our view remains that inflation is tracking lower than 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 new CPI inflation data.
Fundstrat’s head of Research Tom Lee said that as stocks enters a new bull regime, the market could get jolted by volatility depending on how the new inflation data shakes out and how the Fed reacts to that data at its policy meeting on June 13-14.
With market consensus expecting the core month-over-month inflation gauge to be 0.4% for the month of May, investors would be surprised if inflation came in closer to 0.3%. That would be a positive surprise because it would bolster the Fed’s potential decision to pause interest rate hikes this month and in July.
“If May Core CPI [is less than] 0.4%, then we see these odds [of interest rate hikes] dropping to zero for each month,” Lee said in a Friday note.
Lee is confident that inflation is indeed tracking lower than consensus based on real-time measures of CPI, and that inflation is actually nearing the Fed’s long-term target of 2%.
“If this plays out, the Fed’s pause will morph into a data dependent mode, where the bar is raised for further [interest rate] hikes,” Lee said. “We expect investors to see this as a green light for risky assets, which means equity investors will not be fighting the Fed.”
But if the Fed moves ahead with raising interest rates again, investors should be ready to buy a likely decline in stocks, according to Lee.
“Even if the Fed raises rates a few more times in 2023, to us, the key is whether this is in response to rising inflationary pressures. And our view is that these pressures are diminishing,” Lee said.
Bolstering Lee’s bullish case is the fact that market breadth is beginning to expand, which is a healthy sign for the sustainability of the current rally. In other words, more and more stocks are beginning to participate in the upside, rather than the rally being drive by just a handful of mega-cap tech stocks.
“Market breadth is notably improving,” Lee said, pointing to the outperformance of small-cap stocks this week. “Still want to buy dips as market breadth expanding.”
Lee continues to recommend investors stay overweight to the industrials and regional bank sectors, and he reiterated his 2023 year-end S&P 500 price target of 4,750, representing potential upside of 10% from current levels.
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