The stock market could still rally to new highs by the end of the year as plunging oil prices help tame inflation, Fundstrat's Tom Lee says

  • Stocks have approached the “no bid” situation seen in June, yet they could still rally to new highs by year-end, according to Fundstrat.
  • The research firm pointed to plunging oil prices as yet another sign that inflation is “dropping like a rock.”
  • “Further declines in gasoline should also lower consumer inflation expectations,” Lee said.

Recent stock market volatility shouldn’t prevent the S&P 500 from reaching new highs by year-end, Fundstrat’s Tom Lee told clients in a Friday note.

The 6% sell-off in the S&P 500 since Fed Chair Jerome Powell’s Jackson Hole speech last week has led the stock market to a “no bid” situation akin to the mid-June low, as worries mount and few near-term catalysts are seen driving a rebound, according to Lee.

“There is a lot [of] trepidation about markets in September. The seasonals worry investors (one of the toughest months), coupled with midterm election uncertainties and the painful three-week downtrend in stocks adding to the misery,” Lee said.

And yet, the S&P 500 could still surge to record highs before year-end, according to Lee. That’s because inflation is “dropping like a rock,” and could continue to do so as oil prices plunge.

He observed that at $86 a barrel, WTI crude oil prices are now $6 below pre-Russia/Ukraine war levels, and well below Wall Street forecasts for $140 oil prices. 

“Oil is within reach of falling to [the] start of 2022 levels…this breakdown would amplify the ‘disinflation’ tailwinds,” Lee said, adding that with summer over, peak driving season (and demand) is now in the rear view mirror.

“The idea [that] inflation would be sticky… was based upon oil rising to $140 or higher,” but that’s no longer the case, Lee said.

Ultimately, Fundstrat forecasted that falling gasoline prices could subtract -0.60% month over month from the CPI in August. And further declines in gasoline should also lower consumers’ expectations for future inflation, which is a crucial component of taming prices too, he added.

As evidence grows that inflation is cooling off, that should be a boon for stock prices as it could hasten a pivot away from outsized interest rate hikes by the Fed.

Other factors boding well for stock prices are a resilient corporate earnings backdrop, rock bottom investor sentiment, and the strength of the US economy relative to its developed peers, according to Lee.

“Bottom line, we see second half [stock market] rally thesis intact,” Lee concluded.