Stocks could see double-digit gains in 2023, as these 3 factors show the Fed has already succeeded in taming inflation, Fundstrat says

• The Fed has already tamed inflation, and that could set stocks up for a blistering rally in 2023, according to Fundstrat's Tom Lee.
• He predicted a double-digit gain in the S&P 500, pointing to various cooling inflation indicators.

Stocks could see double-digit gains in 2023, as three indicators that show the Federal Reserve has already succeeded in taming inflation, according to Fundstrat's head of research Tom Lee.

A stock rally of that size would hinge on the Fed loosening financial conditions, after raising rates an aggressive 425 basis points over the last year to rein in inflation. That policy move led the S&P 500 to post a 20% loss in 2022, marking its worst performance since 2008 – but softening inflation data sets up a pivot, Lee said.

"If this is correct, we believe [the] Fed will allow financial conditions to ease," Lee said, adding that financial conditions could even soften before the next Fed meeting in February, since they are responsive to public comments from officials. "That is, it is less about rate hikes, but more about whether the Fed views current policy as sufficient to achieving its goals."

1. Inflation indicators are dropping rapidly – and some show inflation back to the Fed's 2% target.

While the headline Consumer Price Index is up 7.1%, still well above the Fed's long-run target of 2%, three-month annualized core CPI for December could show a reading of 2.68%.

Meanwhile, he estimated the core Personal Consumption Expenditures index, which is the Fed's preferred inflation gauge, is tracking around 2.04%.

"Both figures are ~2% and means Fed 'mission accomplished' as inflation is running at 2%. And thus, we think sets up for a Fed to make a 'dovish' adjustment to its inflation views in the Feb FOMC meeting," Lee wrote.

2. Commodity prices have rolled over

Commodity prices, like oil, natural gas, and wheat, were a major driver of inflation in 2022 and have eased significantly over the past year. Natural gas fell 10.5% as of the first trading day of 2023, while crude oil was down 4.1% and wheat was down 2%.

That brings the prices of all three commodities to nearly the level at the start of 2022 – a strong indicator that prices have already rolled over and are cooling, Lee said.

3. The labor market has softened significantly

Fed Chair Jerome Powell has repeatedly cited a tight labor market as a reason why the Fed needs to remains restrictive on policy.

But forecasts for November jobs-openings data indicate the labor market has already softened significantly, Lee said, as the expected 10 million openings mean they are down 8% year over year.

Other data suggest openings could even be softer than those estimates, Lee said, pointing to LinkUp's estimate of 9.9 million.

Lee has said in a previous note that the S&P 500 could rally as much as 24%. His bullishness is contrary to other Wall Street commentators, who have warned that stocks could tank as much as 25% early 2023 from battered corporate earnings.