Tom Lee says the worst is over for ‘epicenter’ stocks, small caps, but warns on tech

Published Fri, May 14 20219:17 AM EDTUpdated Fri, May 14 20219:32 AM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Fundstrat co-founder Tom Lee said that so-called epicenter stocks and small caps have reached a bottom, but more pain may be ahead for the tech sector. Epicenter stocks are those that were hit hardest by the pandemic, including airlines, hotels and consumer discretionary companies like restaurants and retailers. The small-cap Russell 2000 was down 4.4% so far this week. Lee said the Centers for Disease Control and Prevention's announcement Thursday t hat fully vaccinated Americans no longer need masks in most situations is an important step toward returning to normalcy. "We think the next steps will be the CDC lifting restrictions on many epicenter industries, including cruise lines, etc.," he wrote. "This would be good for supporting the U.S. economy tracking for a full reopening and return to near normalcy by mid-year." Lee published the call Friday morning, at the end of what he said was a "tumultuous" week with the VIX surging 78%, but then falling 20% in the past day. The VIX is Cboe's Volatility Index and is calculated based on puts and calls on the S & P 500. Lee warned that tech has become a source of cash for big investors, but travel-related stocks and others that benefit from the reopening trade should do better. "There have been multiple downdrafts in equities, triggered by panic associated with headlines," he wrote, pointing to the surge in the Consumer Price Index on Wednesday and selling motivated by the May 17 deadline for 2020 federal income taxes. "Usually, a VIX peak = market bottom," he wrote. Lee added that if inflation is a concern, Treasury yields should be going up and the 10-year, at 1.64%, is lower than it was when it hit 1.77%. "In other words, the bond market was more concerned with inflation in March than it is now. Lee noted that consumer discretionary was the only epicenter group not to outperform the S & P 500 this week. "We think Discretionary is the most crowded Epicenter group, because it is the most familiar to hedge fund and growth managers," he wrote. He said those big investors derisked and sold what they owned: discretionary stocks. As for technology, growth managers are rotating into consumer staples and health care. Lee downgraded tech to underweight last week because it was a crowded trade and upgraded staples to neutral.

Tom Lee, Fundstrat Global Advisors

Scott Mlyn | CNBC

Fundstrat co-founder Tom Lee said that so-called epicenter stocks and small caps have reached a bottom, but more pain may be ahead for the tech sector.

Epicenter stocks are those that were hit hardest by the pandemic, including airlines, hotels and consumer discretionary companies like restaurants and retailers. The small-cap Russell 2000 was down 4.4% so far this week.

Lee said the Centers for Disease Control and Prevention's announcement Thursday that fully vaccinated Americans no longer need masks in most situations is an important step toward returning to normalcy.