Tom Lee: Here's why the bottom in stocks may be near

Tom Lee: Small caps may have signaled market bottom
Tom Lee: Small caps may have signaled market bottom

Movements in small-cap stocks near the end of last month seemed to signal the stock market may have bottomed, longtime bull Thomas Lee said Monday, as investors braced for continued volatility surrounding the Federal Reserve's decision on interest rates later this week.

"Some things that you look for to say a bottom's in are usually small caps outperforming. They almost always turn up one day to two weeks before the actual bottom's in," he told CNBC's "Squawk Box" in an interview. "Small caps bottomed versus the S&P on the 24th of August."

Ed Keon, managing director at Prudential's Quantitative Management Associates, told CNBC in a separate appearance that stocks are still in a bull market but fairly valued at these levels. "I think that the pace is going to be significantly slower over the next couple of years than the last several years."

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As for rates, among Wall Street economists, it appears too close to call on whether central bank policymakers will hike for the first time in nine years after their two-day meeting Thursday.

"I would be surprised if we had a hike this week," Lee said. "Investors between now and year-end want visibility. If the Fed does sort of put things on hold, I think they'd prefer to hear the Fed say, 'We won't really have the door open until next year.'"

Keon said he thinks the Fed could appease everyone with a rate rise and assurances of no more this year. "So you would satisfy the people that want to see some kind of an increase, but at the same time give some certainty about the future course of rates."

Recent concerns about China's economy have been seen as a complicating factor, and government data released Sunday showed growth in the country's fixed asset investment and industrial production missed expectations in August.

As a result, Chinese stocks closed sharply lower, with the Shanghai composite off nearly 2.7 percent Monday, even as Beijing issued new guidance on state-owned enterprise reforms, including the introduction of "mixed ownership" of state firms.

With China and the Fed as wildcards, Wall Street is looking for another winning week, despite running a loss for the month.

"In the last month, I think a lot of people who were bullish and buy the dips have now gone into this indecision camp," Lee said.

Keon said he's not one of them, but he's holding more cash than normal. "If you do get a reaction to the Fed or what's happening in China ... I'd like to have some dry powder to put to work as we did the day the Dow opened down 1,000 [points]."

The day Keon was referring to was Monday, Aug. 24, when the Dow Jones industrial average clawed back some of those earlier losses to close down 588 points or nearly 3.6 percent. He said he did some buying that morning.

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Meanwhile, the Dow is coming off a weekly gain of 2 percent, its best week since March 20. The was also up 2 percent last week, its best for such a time period since July 17.

Historically, September has typically been a weak month for stocks, and both the Dow and S&P were in the red for the year—off more than 8 percent and 5 percent, respectively—as of midday Monday.

"You've seen turbulence at times when the Fed does make its first rate move," Lee said. "But if this is like the 1950s in a low-inflation and low-growth environment it would be seen as a reflation signal and back then it was actually a bullish outcome for stocks."

"There are bullish things developing though," such as signs of stabilization for the dollar and oil prices, he argued.

"Sentiment, which hasn't really mattered in the last month, is so bad that, I think, we're better-positioned for good news than bad," said Lee, who launched his own boutique equity research firm, Fundstrat Global Advisors, last year after leaving JPMorgan as chief equity strategist.

Correction: China released economic data on Sunday, Sept. 13. An earlier version misstated the day.