The S&P 500 could surge 3% by Wednesday amid a trifecta of positive signals, Fundstrat's Tom Lee says

• A trifecta of positive signals could send the S&P 500 soaring 3% by this Wednesday, Fundstrat's Tom Lee said in a note on Friday.
• A rally in junk bonds, a collapse in the VIX, and falling treasury yields all point to a higher stock market.
• "I take this as a risk-on signal, raising the probabilities that the S&P 500 sees 4,400 before month-end," Lee said.
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The S&P 500 is primed for a 3% surge to 4,400 by this Wednesday, Fundstrat's Tom Lee said in a note on Friday.

Lee sees a "trifecta" of risk-on signals driving the stock market higher, including record highs in junk bonds, a collapse in Wall Street's fear gauge, and falling treasury yields.

"This is a positive set-up and something not seen for some time," Lee said, adding that he expects mega-cap tech and energy stocks to drive much of the gains.

The record high in junk bonds on Thursday lends credibility to the recent rally in stocks, Lee said, given that high-yield bonds have historically served as a leading indicator to equities. And according to Lee, the rally in junk bonds is for the right reasons, including a stronger economy and stable interest rates.

Meanwhile, the volatility index collapsed below 16 on Friday, marking its lowest level since the start of the COVID-19 pandemic.

Equity returns have been strong amid similar periods of normalization for the VIX, with the S&P 500 gaining on average 23% over the next 12 months, according to the note. That's in part because as the VIX falls, systematic hedge funds usually add leverage and buy stocks, pushing asset prices higher.

Finally, a decline in treasury yields from their mid-March peak has fueled gains in mega-cap tech stocks, which should continue to drive the market higher going forward, according to Lee.

"While many might fret that interest rates are stabilizing around 1.5%, we think this is a positive risk-on signal," Lee said, before explaining that valuations for fast growing tech stocks usually drift higher during low interest rate environments.

"2021 [is] tracking to be a +20% year," Lee said. The S&P 500 is up about 14% year-to-date as of Friday afternoon.

While it "certainly seems to be a tall order for the S&P 500 to rally to 4,400 before month-end...I think it could happen," Lee concluded.

"OK. Maybe by mid-July," Lee hedged.