Why one of Wall Street's biggest bulls says investors should brace for a 7% drop in the stock market

• Brace for a 7% drop in the stock market after this month, Fundstrat's Tom Lee warned.
• That's due to uncertainty over a potential recession and Fed rate cuts this year, he said.
• But over the course of the year, Lee remains bullish on the stock market.

One of the most bullish forecasters on Wall Street who was spot-on in his 2023 outlook is now warning investors that the stock market will soon take a hit.

Stocks could drop as much as 7% after this month, according to Tom Lee, the head of research at Fundstrat. 

He remains bullish over the course of the full year, but his warning for the near team is unusual for the stock market bull, who correctly predicted the 24% gain in the S&P 500 last year and has said it will notch a fresh all-time-high of 5,200 in 2024. 

"It's possible that we might have something like a minor new high before the end of the month, and we might have something like a 7% drawdown," Lee told CNBC on Wednesday, citing uncertainty on the pace of Fed rate cuts and recent choppiness in economic data. 

Stocks have already started to falter over the last week, partly due to a slew of comments from Fed officials who suggested they're still unsure of how low to take interest rates this year.

Fed Governor Christopher Waller said this week that the Fed shouldn't rush into cutting rates until it was certain it would reach its goal of lower inflation, sparking a brief sell-off in equities.

Meanwhile, there are still signs that the economy needs more cooling before central bankers will be poised to dial back its monetary policy: Inflation accelerated to 3.4% in December, a higher pace of growth than economists expected. Retail sales also came in stronger than expected.

With rates still at the highest level in over 20 years, the economy continues to runs a decent risk of tipping into recession by the end of the year. The New York Fed is pricing in a 63% chance by December, up from a 50-50 chance priced in the prior month.

Those concerns will linger for several months, Lee suggested, which is bound to take stocks lower.

"We're moving to a playbook of inflation is slowing, the Fed wants to keep real rates from getting too high, but we don't know what kind of cuts and when those will happen. That's the nervousness we're going to have over the next six months," he later added.