Tech stocks need to overcome these 5 walls of worry to prevent a further 7% decline, Fundstrat's Tom Lee says

• The decline in technology stocks has more room to go if five walls of worries aren't overcome, Fundstrat's Tom Lee said in a Tuesday note.
• The Nasdaq 100 could drop a further 7% to its 200-day moving average, Lee said.
• These are the 5 "wall of worries" tech stocks need to overcome to prevent further downside, according to Fundstrat.
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The high-flying technology stocks that dominated returns in 2020 have seen their fortunes reverse so far this year amid a "violent rotation" into cyclical stocks, and there could be more downside ahead according to Fundstrat's Tom Lee.

In a Tuesday note, Lee warned that the tech-heavy Nasdaq 100 could drop as much as 7% to its 200-day moving average if it doesn't overcome five "wall of worries." The index's 200-day moving average currently stands at 12,438.

"Essentially, growth needs favorable outcomes on 5 of 5 'wall of worries' to avoid further downside, [while] epicenter only needs a favorable outcome on 1 of 5 to work," Lee explained.

Those walls of worries include inflation fears, higher interest rates, regulation from the Biden administration, a reopened US economy, and an increase in the capital gains tax rate.

"The outcome of these 5 events shifts the balance in favor of one group or the other," Lee said, adding that epicenter stocks only need a few things to work while tech needs all 5 events to work in its favor due to crowded positioning among investment managers.

A rise in inflation, interest rates, and capital gains taxes would benefit epicenter stocks tied to the physical reopening of the economy relative to technology stocks, Lee said. And increased regulation would hurt mega-cap tech stocks. Finally, because most unrealized capital gains are in technology stocks, a hike in the capital gains rate could spur selling as some investors may seek to lock in a lower tax rate.

And if the Nasdaq 100 gravitates to its 200-day moving average, "there will be a panic out of growth stocks," Lee said. That's why Lee recommends investors cut their exposure to tech stocks in half relative to the S&P 500.

"In simple terms, we are saying to cut technology holdings in half and allocate this to epicenter sectors," Lee said, adding that there is urgency to his message. With technology and the FANG mega-cap tech stocks representing 39% of the S&P 500, Lee recommends clients assign just a 19% weight to the sector.

But in the long-term, Lee sees plenty of upside ahead for the tech sector, and believe bargains will be available if the current decline continues.

Lee said in an interview with CNBC on Tuesday that investors should look at companies tied to the supply chain like semi-conductor equipment manufacturers, and believes that the technology sector will ultimately make up 50% of the S&P 500, "if not more" five years from now.