Wall Street analysts are known for getting a lot of market calls wrong. The best money managers of all time have win rates that are only a little better than a coin flip, so, understandably, many analysts' predictions fail to pan out.
While mistakes are common in stock market forecasts, FundStrat's Tom Lee has been mainly on the mark in 2023. He accurately predicted stocks would rally this year, reiterating his bullishness this spring when the S&P 500 was retreating, causing others to worry it would retest last year's low.
Recently, Lee also predicted that August would be a tough month, another call that was on the money. Given his track record, investors may want to pay attention to what Lee thinks may happen next.
Stocks wrestle with high yields and dollar strength
One big reason for the S&P 500's (SPY) -) lackluster performance since July has been increased Treasury yields. Because Treasury yields are used as the risk-free rate in equity valuation models, a rise in the 10-year Treasury note yield from 3.75% to 4.3% reduced investors' willingness to pay more for future cash flows.
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Rebounding strength in the U.S. Dollar hasn't helped stocks either. The relentless pace of Federal Reserve rate hikes last year caused the dollar to soar, denting demand and negatively impacting financial results at multinationals. The dollar fell from last October through June but has risen sharply since July, causing a similar situation this year.
The reason behind the increase in yields and the dollar is the Federal Reserve's perceived path forward on interest rates, but Lee thinks that worries the Fed must increase rates further is misplaced.
Lower inflation could give stocks a kickstart
Although gasoline and oil prices have climbed this summer, the Federal Reserve is most focused on less volatile inflation inputs. As a result, it focuses more attention on core inflation metrics, excluding energy and food prices.
That's potentially good news for investors because Lee believes core inflation will continue lower, giving the Federal Reserve the cover it needs to leave rates where they are rather than increase them.
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"Many cite the fact that oil is up and headline [Consumer Price Index] CPI will be +0.6% or higher, the highest readings since mid-2022," wrote Lee in a post on Real Money Pro. "Energy does impact goods and some services. But recall, the largest weight in Core CPI is housing at 40%, and unless higher oil prices drive up the price of homes, this surge matters less to the Fed stance."
So, while August's headline CPI to be released on Wednesday, Sept. 13, is likely to be higher, core CPI more influenced by shelter could come in lower than expected. If so, the odds of more rate cuts should fall, causing Treasury yields and the dollar to slip, supporting stocks.
"The Street is looking for August Core CPI to come in at +0.20% MoM. We estimate that August Core CPI will come in closer to +0.16% to +0.18%, reflecting downside from airfares, softer used car prices and with possible help from softer shelter OER (owners equivalent rent)," writes Lee.
A potentially cooler inflation number could catch investors offsides, given investors' sentiment has soured over the past four weeks.
"The market has again become a "game of inches" where investors need to be tactically mindful," wrote Lee. "August, for instance, was soft in the start and gained later. And September, the first three days were terrible. We think the weakness was front-loaded this month. We still see equity markets higher by year-end, and once we are through this continued chop, we see the S&P 500 rising to 4,750 or greater by year-end."
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