Stocks could rally 20% before the end of the year on a Republican victory in Congress and a cooler October inflation report, Fundstrat's Tom Lee says

• Stocks could see a major rally by year-end on a Republican victory in Congress and cooler inflation, Fundstrat's Tom Lee said.
• He pointed to expectations of lower inflationary spending if Republicans took the majority in Congress.

Stocks could see a major rally before the end of the year if Republicans eke out a victory in Congress and the upcoming inflation report shows price increases slowing in October, according to Fundstrat's Tom Lee.

In a note on Wednesday, Lee said that he believed it was likely Republicans would take the Senate, and October's inflation report would show core inflation increasing by just 0.4% month per month, down from the previous two months where core inflation increased over 0.6%. Those events could set the stage for a new rally in the stock market, despite the tough rout investors have faced this year.

"This is why we see it as a 'game changer,'" Lee added, predicting that the stocks could rally 20% by the end of the year if those conditions were met.

Investors have been eyeing a Republican victory in midterm elections as a new catalyst for the market. Carson Group's Ryan Detrick noted it could spur the best performing environment for stocks, largely due to expected decreases in inflationary spending from the government.

A Republican-controlled Congress could slash climate change initiatives and push fossil fuel activity instead, which could collectively lower inflation risks, according to Lee. Republicans may also push to dial back support for Ukraine amid its war with Russia, which could expedite a resolution and lower oil prices that have been spiked from the war.

"We see this as positive for equities. And since 1949, equities have performed best under a Democratic White House and Republican-controlled Congress," Lee said, adding that the average 12-month forward return on stocks during those years was around 16%. Meanwhile, average annual headline inflation was just 2.3%, compared to 4.3% inflation when Democrats controlled Congress and the White House.

That's been supported by subtle improvements in market volatility. The current trend in stocks closely follows the path of the rally that took hold in June, where stocks rose over 16%. The Chicago Board Options Exchange Volatility Index, which is seen as a "fear gauge" on Wall Street, has also eased faster than it did in June, which could mean a stronger rally may be in store, Lee said.

Lee has been bullish on stocks all year, even amid growing recession fears on Wall Street, and previously predicted stocks could rally to a new all-time high by the end of 2022, before revising that projection down.