Why Thomas Lee is bullish on stocks

Bull market is not nearly over
Bull market is not nearly over   

Stock market strategist Thomas Lee says there's plenty of proof the bull market still has several years to go, and underperforming fund managers should help drive prices higher into the end of the year.

Lee, who left JPMorgan as chief equity strategist in June, has launched his own equity research firm, Fundstrat Global Advisors. In his first note Monday, he said to "expect a "beta" chase" in the fourth quarter as fund managers struggle to improve performance, and that should drive stocks 5 to 6 percent higher in the fourth quarter.

"This year fund manager performance is the worst since 1997 versus their bench marks," he said in an interview. Lee notes that only 10 percent of fund managers are beating their benchmark by 250 basis points, well below the long-term average of 26 percent of managers.

Read MoreDollar pullback if Fed stays dovish

Thomas Lee
Adam Jeffery | CNBC
Thomas Lee

"Even as fund managers are generally gloomy given the under performance, we expect them to chase "beta" in 4Q," FundStrat's first research report said. Stocks rose 10 percent in the fourth quarter of 2013.

Lee left JPMorgan with a target of 2,075 on the S&P 500 and he's now looking for 2,100 this year, upping it as most strategists on Wall Street have. He was considered one of the most bullish strategists on Wall Street.

"I was probably the highest on the Street," Lee said of the target he set in December. Over the past few months, many strategists bumped their targets up toward 2,000 to meet him, and once the S&P hit 2,000, that sparked another wave of target hikes for this year and next.

Read MoreThis could be the trade of the decade

Lee said one of the reasons he thinks the bull market can run on is because earnings are still below the average increase at a bull market peak. They are up just 24 percent from the last earnings peak, compared with an average 53 percent above the prior peak in past periods.

Tom Lee: Stay bullish into year-end
Tom Lee: Stay bullish into year-end   

His forecast for earnings per share this year is $118 for the S&P 500, and he expects earnings to grow to $129 next year. Earnings growth should help keep the bull market going for at least two or three more years, he said.

Another force that should help drive the market is an increase in business investment. Lee said the market has peaked in the past when investment spending is 27 percent of GDP, and it's currently at 23 percent.

Lee does not expect the Fed's move away from easing and low rates to cause lasting problems for stocks. "I think the Fed is very careful about the collateral damage," he said.

Read MoreFaber's Doomsday money strategy: 'Only lose 50%'

The Federal Open Market Committee meets this week, and Wall Street increasingly expects it to signal that it is preparing to move toward a more normal rate environment.

While the market should keep going higher, Lee said investors will have to be more selective. He likes technology and health stocks.

"There is a regime shift. Once you get into a middle level of a bull market, value stocks outperform," he said.

Some of the stocks he likes are Corning , Duke Energy , Bunge, Exelon, Staples and Wellpoint. As for big cap names that have "momentum," he likes Disney, Merck, Microsoft, Macy's, CVS Health, and TRW.

Disclaimer

By CNBC's Patti Domm