Tom Lee sees a 10% correction coming but says 2021 will still be a boom year

Published Thu, Dec 17 20207:39 AM ESTUpdated Thu, Dec 17 20201:04 PM EST

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Fundstrat's Tom Lee, who called the 2020 comeback before most others, says 2021 should be another strong year for the stock market. But he expects a correction in the first half of the year. Lee predicts the S & P 500 to end this year at 3,800, and he sees stocks eventually jumping to 4,300 in the second half of 2021, according to his outlook sent to clients Thursday. But first he expects a dip to the 3,500 area in the first half of next year. The average 2021 S & P 500 target of strategists surveyed by CNBC is 4,056. The S & P 500 finished Wednesday at 3,701, up 0.2%. The index is up 14.6% year to date. A gain to 4,300 represents a 16% increase from Wednesday's S & P 500 close. "I think we have a 10% kind of pullback, and I think that's a pause that refreshes," Lee said. "We're overbought. ... I think it's going to be a painful correction, but I think in other similar periods where you're starting an expansion, the correction is really short — one or two months. I think it's going to start either February, March or April, sometime in that window and then when you get past the spring, that's when the market starts to rally. The disease should start pulling back." Lee expects the economy to expand as Covid vaccines are rolled out, and he sees the potential for a boom recovery after the pandemic recession of 2020. That expansion will also be fanned by easy central bank policy. "Look at China. China has just boomed. Once people felt it was vanquished, they had a boom. I think that boom is going to happen here," Lee said. Lee said his top sectors for 2021 are the cyclicals that will benefit from a recovery — discretionary, industrials and energy. "I think part of tech ... is going to struggle. It is the most crowded trade. The most crowded trade is owning large cap tech, work from home and FANG. That is where the greatest adjustment will take place during that correction," he said. "I think those would be leading us lower." Some Big Tech is still attractive, and Lee says it may not get hit as hard. "I think the ones that have reasonable multiples, like Google and Apple are going to hold up really well," he said. "But the hypergrowth names, the ones without a lot of earnings underneath them, those become convenient sources of funds. If inflation picks up, this is the stuff hedge funds are going to start shorting." Lee does expect to see inflation, but it should be contained, and he expects that to be a positive for stocks. Moderate inflation can help grow earnings and revenues, but when inflation runs hot, it crushes margins and hurts earnings growth. "There's been a mindset we're in a deflationary world," he said. "If there's inflation, you want to be long assets." Lee expects volatility to be substantially reduced between 2021 and 2023, and the VIX futures curve should normalize. He sees that as a major risk-on signal for cyclicals. The VIX is the Cboe's Volatility Index, based on the S & P 500 puts and calls traded on the options exchange. He expects it to trade below 20. It currently is at 22.50 but was over 86 in March. Lee said fiscal stimulus being discussed by Congress this week will be important for the economy. "I think stimulus is really important because you can't cyclically turn on businesses that failed. They either need to be rescued or the people that have been displaced need to be rescued," he said. "It's a non cyclical factor. It was an earthquake that wiped out, at one point, 20% of the jobs. I don't think natural recovery can fix that." Back in March, Lee was among the first on Wall Street to call a bottom for stocks. "We could see stocks in a seriously strong recovery by summer. And perhaps even all-time highs by year-end," Lee said at the time.

Tom Lee, Fundstrat Global Advisors

Scott Mlyn | CNBC

Fundstrat's Tom Lee, who called the 2020 comeback before most others, says 2021 should be another strong year for the stock market.

But he expects a correction in the first half of the year.

Lee predicts the S&P 500 to end this year at 3,800, and he sees stocks eventually jumping to 4,300 in the second half of 2021, according to his outlook sent to clients Thursday. But first he expects a dip to the 3,500 area in the first half of next year.

The average 2021 S&P 500 target of strategists surveyed by CNBC is 4,056. The S&P 500 finished Wednesday at 3,701, up 0.2%. The index is up 14.6% year to date.