US stocks are due for a “violent” rally in February that could lead to new record highs by the middle of the year, according to Fundstrat.Fundstrat’s Tom Lee believes a lot of bad news is already priced in the stock market.”When markets are this fragile and nervous, the probability for positive surprise is higher,” Lee said.Sign up here for our daily newsletter, 10 Things Before the Opening Bell. The stock market is set for a “violent” rally in February after a series of mega-cap tech earnings rocked investor confidence this week, according to a Friday note from Fundstrat’s Tom Lee.
Lee’s expectation that the stock market will surge to new record highs by the middle of the year stems from the fact that, according to Lee, a lot of bad news is already priced into the market.
That’s especially the case after poorly received earnings results from tech companies like Facebook-parent Meta Platforms and PayPal led to swift one-day declines of about 25%.
“Facebook decline does not negate violent February base case [for rally],” Lee said. Specifically, Lee observed that retail investors put $53 billion into money market funds over the past two months, retail investor sentiment has dropped to its worst reading in eight years, and markets sold everything on Thursday after Facebook’s weak print.
“To me, when markets are this fragile and nervous, the probability for positive surprise is higher,” Lee said.
Driving Lee’s confidence in the market is the continuation of strong corporate earnings results, along with the sharp retreat in COVID-19 cases over the past few weeks.
Of the 53% of S&P 500 companies that have reported earnings so far, 80% are beating income estimates by a median of 6%, while 75% are beating revenue estimates by a median of 4%.
Those results suggest “operating leverage [is] still in place,” Lee said. Meanwhile, daily cases of COVID-19 have plunged 90% from their peak in New York and Connecticut. That should help improve consumer confidence and also help the labor market as more people seek to get back to work, according to Lee.
Lee derived his bullish projection for a record stock market rally to occur over the next few months from historic price action following a “waterfall decline,” according to the note.
“The S&P 500 posted a waterfall decline of 11% peak to trough over 14 days. While many things seem common in this pandemic era, a fall of this velocity is actually rare,” Lee explained, adding that this type of market action “flies in the face of those saying markets are in a bubble and investors are too bullish.”
What happens next after such declines is encouraging for bullish investors, according to data compiled and analyzed by Fundstrat.
In the past ten years, there have only been five instances where such a dramatic fall occurred. “Five of the five times, this was at the end of a sell-off, not the start, and markets staged a fierce and violent rally after each of those,” Lee said.
Forward three-month and six-month returns are 7.1% and 13.0%, according to the note, which implies the S&P 500 could surge above 4850 before the end of the first half of this year.
“This reinforces our view that markets can stage a strong rally from January lows into February,” Lee concluded.