Stocks will rally 5% in just 5 days after the Fed's rate decision this week, Fundstrat says

• The stock market could see a 5% gain over the next week, according to Fundstrat's Tom Lee.
• The rally would be sparked by a dovish Fed FOMC meeting on Wednesday that all but confirms imminent interest rate cuts.

The stock market is poised to surge as much as 5% in the next week, according to a Wednesday note from Fundstrat.

The research firm said it expects an explosive rally in the S&P 500 to materialize in the five days following the Federal Reserve's FOMC meeting on Wednesday.

While the Fed is not expected to cut interest rates at its July FOMC meeting, it is expected to signal that a rate cut is all but certain when it meets again in September.

"The key premise is the Fed is likely to commit to a September rate cut of at least 25bp. A possibility of more than that is not necessary. And while bond markets have priced in 100% probability of this, equity investors likely will not be convinced until the Fed affirms this as such," Fundstrat's Tom Lee said.

The near certainty of a rate cut from the Fed in September should spark a risk-on rally for stocks, especially given that the Nasdaq 100 has already experienced a near-10% correction in recent weeks, according to the note.

"Overall, we believe risk-on moment is coming," Lee said.

Lee's confidence in a strong rally post-Fed meeting is based on the fact that recent Fed meetings have sparked a big rally in stocks.

In the past two years, when stocks were down heading into a Fed FOMC meeting, stocks saw a five-day gain of as much as 5.5% and a median gain of 3.4%.

"These are significant gains, implying the S&P 500 could gain 200-300 points in the next week. This is very compelling in our view," Lee said.

And while a 25 basis point interest rate cut may not seem like much, it has real-world economic impacts that could ultimately influence the US housing market in a big way.

"Here are some tangible reasons a Fed cut makes sense: 30-year mortgage has excess spread to 10-year due to uncertainty. The spread could shrink from 270 basis points to 170 basis points (50-year average)," Lee explained.

Interest rate cuts from the Fed, however small, would also help alleviate an ongoing slowdown in the housing, durables, and auto markets, Lee said.

A 5% rally in the S&P 500 would catapult the index to fresh record highs, completely erasing its 5% decline over the past few weeks.