- The stock market has bottomed and will rally into year-end, according to Fundstrat's Tom Lee.
- "Literally this is a textbook bottom, and a sign of capitulation," Lee said in a Wednesday note.
- There are the three signals that suggest to Lee the market has capitulated and is setup for a rally.
The week-long decline in the stock market, sparked by fears of the new Omicron COVID-19 variant and a potential policy pivot from Fed Chairman Jerome Powell, is likely over, according to Fundstrat's Tom Lee.
In a Wednesday note, Lee pointed to three factors that suggest the market has capitulated and is setting up for a year-end rally. Those factors include two 90% down volume days, the price action in Wall Street's fear gauge, and a disbelief in Powell's potential policy pivot.
"Two 90% down days are a sign of a bottom, not a top," Lee said, referring to down trading volume in New York Stock Exchange listings hitting extreme levels. Each 2% market sell-off on Friday and Tuesday was so widespread and touched so many stocks that 90% of the volume on those days were associated with selling rather than buying.
But over the past two years, instances of two 90% down trading days occurring within a period of five trading days has represented a buyable dip of a sell-off that was set to reverse, according to Lee.
"The panic selling due to Omicron and Powell have created sufficient selling to establish a tradable low," Lee said.
Additionally, price action in the VIX suggests that investor fear has peaked and is set to decline, which would be constructive for stock prices. Importantly, Tuesday's decline in stocks sent the VIX higher, but not as high as Friday's levels.
"The carnage on Tuesday did not bring in a surge of investors seeking protection. In other words, the derivatives markets diverged from the market carnage," Lee said, pointing to stocks making a new relative low on Tuesday while the VIX made a lower high.
Finally, Fed Chairman Jerome Powell's testimony to Congress surprised investors on Tuesday, as he suggested that a potential policy pivot is possible despite the threat of a new coronavirus variant. Powell said the Fed could speed up its taper of monthly bond purchases, and could even raise interest rates sooner than expected.
But the market isn't buying it, Lee said, pointing to a decline in odds that the Fed raises rates next July. "If the Fed is shifting its inflation view, towards one where inflation risks are no longer transitory, then one should expect the risks of Fed lift-off to be rising," Lee explained.
Instead, the opposite is happening: Fed odds of an imminent rate hike have fallen considerably since October, according to Lee.
"We don't want to be shouting at the market, but in our view, equities sold off on what we believe are transitory factors," Lee concluded.
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