Tom Lee says there's a chance the Fed pauses hiking for all of 2023, sparking a massive stock rally

Published Thu, Dec 22 202212:00 PM EST

Fundstrat's widely followed equity strategist Tom Lee made the case for a collapse in inflation that will cause the Federal Reserve to slam the brakes on its tightening campaign, lower volatility on Wall Street and spark a sizable stock market comeback. Lee believes we may get signs as early as this week that inflation is heading back towards the Federal Reserve's 2% target. On Friday, the core PCE inflation index will be released and Fundstrat expects that will come in at a 0.15% month-over-month increase. Also on Friday, the University of Michigan consumer survey will be released, containing the 12-month inflation expectations of Americans. Fundstrat sees that coming in at 4.4%, also below current Wall Street expectations. Finally, on Jan. 12, December's CPI will be released and Fundstrat said the core numbers, excluding food and energy, will also reflect a "massive collapse" in inflation. Fundstrat said these reports will show that on a three-month annualized basis, core inflation is already tracking near the Fed's 2% target and much below the central bank's official inflation forecasts. Therefore, the central bank will pivot policy sooner than expected, it said. "Fed framework likely changes to 'predictable Fed' as inflation is now operating near their long-term goal of 2%," wrote Lee in the note this week. "This would be a massive dovish pivot, in our view, and could mean Fed pauses entirely in 2023 (maybe)." Lee's call is well outside expectations on Wall Street. Traders expect the Fed to raise rates at least a quarter point in February and again in March, according to fed funds futures. Being a contrarian is not unusual for Lee, who was among the first to call the market comeback during the pandemic. However, Lee stayed too bullish heading into 2022 as the S & P 500 tumbled more than 18% for the year. Volatility easing to spark big rally The next piece of the Lee's theory is that as the Fed changes its policy, stock market volatility will collapse. Fundstrat noted that the CBOE Volatility index averaged above the 25 level this year, an "extraordinary" high number that was only surpassed in 2008, 2009, 2020, 2002 and 2001. The so-called VIX is derived from option prices on the S & P 500. The typical VIX decline from such high levels is 20% and when Wall Street's fear gauge drops by that much, stock gains average 20%, Fundstrat data shows. Fundstrat also noted that positive returns are consistent when the VIX declines. There were 19 times when the VIX's 12-month average declined versus the prior year and on 18 of those occasions, the equity market was higher. How to play it Lee has a number of stocks he's recommending to clients to play the comeback. Among his top picks are Apple , Alphabet and Microsoft as the strategist expects it's time to buy the dip in Big Tech. Other names on his picks list are CF Industries , Allstate and Amgen .