The stock market could soar to new records in another 1982-style vertical rally as inflation continues to ease, Fundstrat says

• Stocks could rise abruptly and cause the S&P 500 to hit 4,400-4,500 by the end of the year, Fundstrat's Tom Lee said.
• Easing inflation means markets will start discounting hawkish Fed comments, which have weighed on stocks all year.

If inflation continues to slow faster than the Federal Reserve expects, stocks could soar in a 1982-style vertical rally and touch new records, according to Fundstrat's head of research Tom Lee.

In 1982, the S&P 500 rebounded so sharply that in just four months it recovered from a 27-month bear market, he pointed out in a note on Tuesday.

"Markets have priced in 'Fed hawkish' mode as [the] Fed has to be taken at face value," Lee said, referring to comments from Fed officials that have kept stocks depressed all year.

Though central bankers have recently suggested softening the pace of rate hikes, Cleveland Fed President Loretta Mester recently said more progress was needed on inflation, and Chairman Jerome Powell said he saw no case "for real softening just yet" in monetary policy, as inflation still remains well above the central bank's 2% target.

Such comments, along with the Fed's 375 basis points of rate hikes so far this year, have led the S&P 500 to slide 16% since January and precipitate a historic drop in CEO confidence. But that could actually mean good news for stocks: it's a sign that the Fed's hawkishness has already been priced into the market, meaning more inflation prints below consensus could cause stocks to surge.

"If inflation softens faster than the Fed expects (which is also what consensus expects), this could shape up to be a 1982 moment," Lee said.

In his view, it could cause the S&P 500 to rally to 4,400 to 4,500 by the end of the year — a 12% rise from current levels.

Consumer inflation has been slowing for months, with prices up 7.7% in October, down from 9.1% in June. And despite concerns prices will stay high into 2023, Lee pointed to evidence of transitory inflation pressures, such as lingering supply-chain issues, rebounding demand after the pandemic, and "revenge" spending in sectors like travel.

Those have all contributed to inflation but will die off eventually, Lee said, dragging prices even lower.

"Thus, the Fed did not need to go full Volck-an to fight inflation," he added, comparing Powell to former Fed Chair Paul Volcker, who famously raised rates to 20% and caused a deep recession to get inflation under control.

Other experts have noted major pieces of inflation data often lag behind the official statistics by around 18 months, and the Fed's rate hikes also work with a lag in the economy. That could mean inflation is already well on the way down, eventually prompting the Fed to ease up monetary policy and give stocks some room to breathe.

Lee has been bullish on stocks amid the tough market rout this year. He's previously said the S&P 500 could rally to another all-time high of 4800 by the end of the year, before revising that prediction downward.