The market may appear to be shrugging off escalating tensions with North Korea, but Wall Street strategist Thomas Lee believes investors shouldn't get too comfortable.
Lee, who had been one of the Street's most bullish strategists but is now among its most bearish, doesn't see a great risk reward and is urging clients to use discipline in the stock market.
"What gets us worried is that these geopolitical tensions have a chance of escalating at a time when I think Washington is not running like a smooth machine," Fundstrat Global Advisors' co-founder said Wednesday on CNBC's "Trading Nation."
"With a fiscal cliff coming and some major reform bills that investors have been banking on, I think it does create sort of the kind of headline events that could end up triggering a big jump in volatility."
The major indexes are coming off their second negative session in a row. The S&P 500, Dow and Nasdaq fell by fractions of a percent, but they're still up at least 15 percent since the November presidential election.
"You'd expect investors to be taking some action. I think it really speaks to ownership of the equity market today — that passive funds aren't necessarily going to react to headlines like this," said Lee.
He expects the S&P 500 to fall by 8 percent to 2275 by year's end and doesn't see any major catalysts to drive stocks higher.
"We don't necessarily have a major election on the horizon or any major deadlines," he noted. "It's still going to be a market where you want to be more focused on sectors than banking on a big move in the indexes."
And, he said there's one area in particular that could give investors solid returns in this environment.
Lee also has a sector pick that's been out of favor.
"Some of the laggards, the pariahs of this market, are the ones which really interest us. Telecom services, for instance, is one of the worst sectors this year," Lee said. "There's a potential catalyst coming with the FCC deciding what to do with Title II which is net-neutrality. Their final word is expected before the end of this year."