Stocks are flashing four signs that the "ugly" sell-off in markets is about to turn around, Fundstrat said.
Tyler Le/BI
It's a prime time for investors to buy the dip in stocks, with the market flashing a handful of signs that there's more upside on the way, according to Fundstrat's head of research Tom Lee.
The ultra-bullish analyst, who's previously predicted the S&P 500 could nearly triple by the end of the decade, says the ongoing tech-driven stock sell-off is actually a buying opportunity.
It's a bold short-term call given recent wreckage in the market. The tech-heavy Nasdaq 100 has lost nearly 5% in just two days amid disappointing earnings reports and volatility in the chip sector.
Lee says the sell-off has likely been fueled by a culmination of factors, such as uncertainty surrounding the presidential election, lingering geopolitical tensions, and ongoing concerns over a recession.
But there are signs that the sell-off will ultimately be limited, according to Mark Newton, the firm's head of strategy.
"Overall it's still tough for me to put too much credit into Thursday's price action as to having 'changed the trend' or 'broken any trend' and uptrends remain intact," Newton said, noting a technical support level of 5,390 for the S&P 500. "I'm willing to bet that Technology is also bottoming, and I cannot get too negative following this pullback."
Lee also outlined four reasons why markets were likely experiencing a "normal pullback," as opposed to investors panicking over the risk of a potential recession.
Central bankers are expected to deliver more guidance on rate cuts in the weeks following their last policy meeting. That could shift markets in a more positive direction, Lee said, if Fed officials hint a rate cut is coming soon.
July's inflation reading, meanwhile, is set for release on August 11. Cooling inflation could also bolster confidence in rate cuts, which could boost stocks.
"This likely allays the 'Fed is making a mistake' fears," Lee added.
Markets are feeling pretty optimistic about the path of interest rates later this year. Investors have priced in with certainty that the Fed will begin cutting rates in September, and that central bankers could cut rates 100 to 125 basis points by the end of the year, according to the CME Fedwatch tool.
There isn't much evidence that poor-performing areas of the market, like small-cap stocks, have peaked, Newton said. Meanwhile, Treasury yields have fallen in recent months as traders anticipate Fed rate cuts, which is typically bullish for stocks, he added.
"Thus, looking to buy dips makes sense technically," he said, adding that small-cap stocks looked "certainly appealing" after their recent slide.
That's because rate cuts are expected to ease borrowing costs across several sectors. Certain types of debt, like adjustable rate mortgages and auto loans, are financed under short-term interest rates — meaning those sectors are "positively impacted" by rate cuts, Lee added.
The Russell 2000 hit a 30-month high in July, something that's only happened nine times over the past 45 years. In every instance, the index was higher three months later, Lee noted.
The index has also posted small moves, gaining or losing less than 1% in 11 of the last 12 trading days. That's only been seen 10 times over the past 45 years, and in every instance, the index was higher 6 months later, he added.
Fundstrat is among the most bullish of Wall Street firms at the moment. Recently, Lee has been calling for a 40% surge in small-cap stocks, thanks to a slew of positive signals being flashed among small-cap companies.
