The stock market was in risk-off mode last week as a continued spike in bond yields sparked a sell-off in technology stocks.
The 10-year US Treasury yield hit a pre-pandemic high of 1.75% and a sizable decline in oil prices constrained the energy sector. On top of that, a speech from Fed Chairman Jerome Powell failed to quell investor concerns about rising inflation.
However, Fundstrat’s Tom Lee described the recent market weakness as nothing more than “textbook chop” that should set stocks up for a sizable rally this coming week, in part driven by increasing vaccine penetration and improving household confidence, according to a Thursday note.
Detailed below are the seven reasons why Lee expects the stock market to recover its losses and move higher this coming week.
“We know financial markets have developed inflation anxiety, given the absence of inflation risk for the past 20 years, and arguably the last 40 years. Thus, it is understandable to see ‘fire, ready, aim’ every time interest rates surge,” Lee said.
“While 10-year rates surged on Thursday, the VIX hardly budged. It was less than 30 last time the 10-year was above 1.6%. So, we are not seeing hedge funds seeking broader market protection, nor is today necessarily triggering a bigger de-grossing event,” Lee said.
“The bond market, particularly credit, is currently functioning well, even as rates rise. This is critical. I would be far more concerned if 10-year was rising and we heard stories of diminishing fixed income and credit liquidity. This is not the case. And if it was the case, the VIX would be more than right now. It is at 21.6,” Lee said.
The quadruple witching event
“Friday is a ‘quadruple witching event’ where single-stock, single-stock futures, index options and index futures expire. These are known market instability events due to the gamma hedging and other activities by dealers. Moreover, given the rising popularity of call options, and the associated skew, this quadruple witching likely carries more weight,” Lee said.
Stimulus checks start to impact the economy
“The economy is on a far stronger path of recovery than compared to any expectations at the start of 2021. In fact, stimulus checks are only starting to filter into the economy. This is going to be a known positive tailwind for multiple cohorts: retailers, recipients of spending, household confidence (get substantial liquidity) and this ultimately has a positive spill-over for stocks,” Lee said.
“Epicenter and Cyclicals outperformed in March and today the weakness was far more acute in Technology and Communications Services. These are the crowded growth trades. In other words, this is not a change in market character. This is simply the acceleration of the rotation out of crowded Growth into Epicenter. It is going to be sloppy,” Lee said.
After market highs
“After markets make new highs, a pattern of chop for 7-10 days follows. This certainly is at play today. But as we wrote last week, we think the highest probability is a +10% move to S&P 500 4,300. This is still our base case,” Lee said.