Investors 'must still buy the dip' because the Fed's easy monetary policies act as a 'backstop' for the stock market, Fundstrat's Tom Lee says
- Despite the stock market's "horrific" slide since selling began last week, investors "must still buy the dip," Fundstrat's Tom Lee said in a note on Thursday.
- The most important factor that sets stocks up for a year-end rally is easy monetary policy from a dovish Fed, according to the note.
- "Ultimately, if the Fed is dovish and monetary policy is easy, markets have a backstop," Lee said.
- On top of that, improving COVID-19 case trends and continued strength in the economic recovery suggest the better risk-reward in the market right now is in "epicenter stocks."
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The sharp three-day decline in stocks that began last week was "horrific" according to Fundstrat's Tom Lee, but a message derived from Wednesday's rebound suggests investors should stay calm and "still buy the dip."
That's according to a Fundstrat note sent to clients on Thursday, which pointed to the Fed as the message investors should pay attention to.
In the note, Lee highlighted a dovish Federal Reserve and its easy monetary policies as the ultimate factor that supports a year-end rally for stocks.
The monetary policies enacted by the Fed since the COVID-19 pandemic began earlier this year include slashing the Federal Funds rate to near 0%, buying corporate and municipal bonds to help shore up the credit market, and directly lending to small and medium-sized businesses.
All together, the Fed's balance sheet has expanded by nearly $3 trillion to $7 trillion since the new stimulus measures went into place six months ago, according to data from the Federal Reserve.
The dovish Fed policies enacted in response to the COVID-19 pandemic pale in comparison to the Fed's response to the Great Recession of 2008. In 2008, Fed stimulus policies resulted in its balance sheet more than doubling to $2 trillion from $1 trillion.
But it wasn't until 2013, five years after the 2008 recession, that the Fed's monetary policies of quantitative easing expanded its balance sheet by $3 trillion from its 2008 pre-recession level.
"Ultimately, if the Fed is dovish and monetary policy is easy, markets have a backstop. In other words, we must still by the dip." Lee said.
And there's little sign the Fed won't remain dovish for the next few years. Last month the Fed announced an overhaul to its framework that now targets an average rate of inflation of 2%. The move signals that even after an economic rebound, the Fed will likely leave interest rates low to help fuel full employment.
Lee suggested investors will find a better risk-reward set up in the "epicenter" stocks, or stocks that were hit hardest by the COVID-19 pandemic and stand to benefit from a reopening economy. He said the improving COVID-19 case trends in the US and strength in the economic recovery favor the reopening trade.
While investors may be scared to own cyclical stocks, which have little earnings visibility and are not obvious winners from the pandemic, "they are going to be primary contributors to EPS growth in 2021, thus, we see better risk/reward," Lee said.