Tom Lee has been helping professional hedge fund money managers navigate bull and bear markets since the 1990s. He was among the few who correctly called for a stock market rally this year, making him worth paying attention to.
He offered up his latest take on what's next for stocks on Aug. 8, suggesting one big event could cause a big move higher in stocks. Here's what Lee is watching and why he thinks markets could see more upside.
Expectations have shifted, setting up this upside opportunity
Inflation was sky-high in 2022 because of post-covid demand from stimulus, low rates, and supply chain disruptions. For example, the CPI inflation report showed prices grew 9.1% year-over-year in June 2022.
It's been a different story this year.
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In June 2023, year-over-year inflation retreated to 3% following a series of Fed Funds Rate increases and fewer supply chain problems. The most significant cost declines have been due to lower commodity prices, including oil and gas.
The improving inflation picture has supported stocks, contributing to double-digit gains for the S&P 500. However, a recent uptick in commodity prices has increased worries inflation will rise again, causing stocks to pull back since mid-July.
Stocks' retreat could be short-lived, according to Lee. While others expect inflation to pick up, Lee isn't convinced.
His research suggests that core CPI will be cooler than predicted, potentially leading those who sold stocks because of inflation worries to become buyers again.
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Lee's research suggests that July's month-over-month increase in core inflation will be a relatively tame 0.15%. That's below Wall Street's 0.22% consensus estimate and far below the Cleveland Fed's Nowcasting target of 0.40%.
"The problem with the Cleveland Fed forecast model is it is a relatively simple 9 variable model that uses gasoline plus the prior month's CPI forecast to forecast July," wrote Lee in a post on Real Money Pro.
Lee's outlook for cooler inflation is due to lower auto and shelter costs. Auto and shelter accounted for two-thirds of the increase in core CPI since 2019, according to Fundstrat. In June, shelter alone represented 70% of the increase in headline CPI, according to the Bureau of Labor.
That's important because the calculation for shelter costs reflects historical lease rates rather than current advertised rents. As leases renew, the shelter component of CPI should play catch up, removing a major headwind that's keeping inflation high.
The July CPI data will be reported on Aug. 10. If Lee is correct, a decline in shelter could spark a rally.
"In our view, this positive surprise would be more than enough to offset the "tape bombs" that rattled markets on Tuesday. And we also think it is enough of a surprise for stocks to recover their losses from Tuesday and even possibly from earlier in August," wrote Lee. "BOTTOM LINE: We think the fundamental catalyst of CPI likely triggers a sizable recovery in stocks."
