The stock market can return to record highs this year as inflation shows signs of cooling down despite May's hot CPI print, Fundstrat says

·3 min read
Tom Lee
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  • The stock market is primed for strong returns in the second half as inflation shows signs of cooling, according to Fundstrat's Tom Lee.

  • That's despite a hot CPI print in May, which showed inflation rise 8.6% year-over-year as gas prices surge.

  • "We stick with our view that stocks strengthen in 2H and even revisit prior highs," Lee said.

The stock market is poised for a strong second half of the year as inflation shows signs of cooling down, Fundstrat's Tom Lee said in a note on Friday.

That's despite Friday's hot CPI report, which showed inflation rose 8.6% year-over-year in the month of May, well ahead of estimates for a rise of 8.3%. That represents the fastest pace of US inflation in 41 years.

The CPI report illustrates that inflation may not have yet peaked as markets had hoped, as oil prices continue to march higher, and that the Federal Reserve may have to raise interest rates more than expected to tame higher prices. The market currently expects the Fed to raise interest rates by 0.50% at each of its next two meetings.

But none of that is budging Lee's view that stocks could revisit its prior highs by the end of the year, according to the note.

"We stick with our view that stocks strengthen in 2H and even revisit prior highs," Lee said. Part of Lee's confidence stems from the fact that certain commodities and economic activity are weakening faster than expected, which should help put a lid on rising prices and give the Fed some breathing room in their rate hike trajectory.

These are some of the signs Lee is looking at as a sign that inflation will begin to cooler faster than expected.

1. "US Mortgage applications plunged to lowest level in 22 years... this portends a dual hit to home prices (negative shock) and possibly [a] 60% drop in mortgage banking employment," Lee said.

2. "Fertilizer prices are down 34% from peak," Lee said.

3. "There are signs that corn, cattle and wheat prices might be plateauing," Lee said.

4. "Global supply chain strains seem to be easing... this points to possible accelerated declines in goods pricing," Lee said.

5. "Oil remains elevated, but oil is becoming a barometer for the Russia-Ukraine war and as long as hostilities escalate, oil is higher. But this is somewhat binary. Cessation of hostilities likely dramatically impacts inflation perceptions," Lee said.

All-in, these data points suggest to Lee that the stock market has already discounted a growth scare in the economy given its sell-off of as much as 20%, and that only a hard economic landing would justify further downside, according to Lee.

One possible sign of "green shoots" investors should monitor to confirm if stocks will have a strong second half of the year is if the Nasdaq 100 and Chinese stocks outperform the broader market, as that has previously helped investors identify bottoms in the market.

"Both indices would not perform well if inflation risks are rising. Nor would these outperform if the global economy was headed for a 'hard landing," Lee said.

The Nasdaq is barely outperforming the S&P 500 from the May 24 low, but that outperformance is slipping on Friday thanks to its sharp decline of more than 3%.

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