6 reasons why the stock market is poised to see its strongest rally of 2023 over the next 2 months, according to Fundstrat

  • Fundstrat’s Tom Lee expects a strong stock market rally over the next eight weeks after February’s sell-off.
  • He said favorable seasonals, cooling inflation, and reasonable valuations will help drive stocks higher.
  • These are the six reasons why Lee is expecting a big rally in stocks between now and May. 

There are six reasons why the stock market is poised to shake off its February weakness and surge over the next eight weeks, according to Fundstrat’s Tom Lee.

He highlighted that the sell-off in stocks that started during the second half of February is following a historical playbook that typically leads to strong gains in March and April, and per usual, investors are not prepared for the potential upside ahead.

“This is a scenario that many investors are hesitant to embrace because of the understandable lack of clarity on inflation trajectory, Fed policy path, earnings risk and general heightened concerns about recession,” Lee said in a Friday note.

But there are plenty of reasons why investors should drop their tendency to lean bearish amid all of the uncertainty, according to Lee.

1. Improving inflation environment

While data for January showed an acceleration in inflationary readings, Lee expects those to have ended and sees inflation continuing its trend of cooling in the weeks and months ahead.

“Beginning next week, will be incoming February economic and inflation data, which we believe will show ‘softer’ jobs and ‘softer’ inflationary pressures. This will reverse, to an extent, the somewhat alarming surge in inflation and jobs data of January,” he said.

2. Fed sticking to 25-basis point rate hikes

Lee expects Federal Reserve Chairman Jerome Powell to stick to 25-basis-point interest rate hikes, rather than reaccelerate its rate hikes back to 50 or 75 basis points. Powell will soon give testimony to Congress “and we expect Powell to reinforce the ‘data dependent’ message,” he said.

3. The bond market is set to rally

“The bond market will likely pivot dovish in March. The ‘hot’ January inflation data caused the bond market to price in higher odds of +50 basis point [rate hikes] in March and April, and Fed speak seems to be pushing back against that – meaning, Fed is less hawkish than recent move in bonds,” Lee said.

Yields have jumped in recent weeks as bond sold off, weighing on stock prices.

4. Falling volatility

“If the incoming data tilts the way we expect (softer), then bond volatility should fall, which supports a stock rally in March to April. This means VIX could fall, and a falling VIX is supportive of higher equity prices,” Lee said.

5. A supportive seasonal environment

There are numerous seasonal factors that point to higher stock prices in the coming months, according to Lee. Those include what early-year gains imply for the spring and the third year of the presidential cycle being the strongest for equity returns, among others.

“We have been using the composite of ‘rule of 1st 5 days’ using the 7 percent years where gains are greater than 1.4% in the first 5 days (ala 2023). This composite implied market gains into February 16 and a consolidation thru early March… This same composite now implies March to end of April will be the strongest 8 week period for 2023,” Lee said.

If the seasonals play out like Lee expects, the S&P 500 could rally 7% to about 4,250 by the end of April.

6. Reasonable stock market valuations

“I am not sure I agree with those who say the stock market is expensive. I think many cite this as another ‘confirmation bias’ to stay on the sidelines,” Lee said, adding that the forward price-to-earnings ratio of the S&P 500, excluding its mega-cap tech giants, is just 14.8x.

“These are not demanding valuations.”