The stock market will rally into year-end on a wave of dovish Fed comments, Fundstrat says

• A wave of dovish comments from the Federal Reserve solidifies the chances of a strong year-end rally for stocks.
• Fundstrat's Tom Lee said sellers are getting exhausted following a two-month long market decline.
• "This cycle is all about breaking the back of inflation, not breaking the economy."

Investors should prepare for a strong year-end rally in the stock market after a wave of dovish comments from the Federal Reserve, according to Fundstrat's Tom Lee.

In a Wednesday note, Lee highlighted that remarks from Fed officials Michael Barr, Richard Clarida, Philip Jefferson, Lorie Logan, and Raphael Bostic over the past week coincided with stock market sellers getting exhausted.

Seller exhaustion has been evidenced by a soft VIX, falling bond yields, cooling oil prices, and the fact that stocks have steadily moved higher despite a sharp increase in geopolitical risks with the breakout of war between Israel and Hamas.

"The macro picture has been challenging since the start of 2022, and in 2023, arguably has deteriorated as the Ukraine war drags on and we have the political circus in the US, and now the Israel-Gaza war," Lee said. "However, equity markets have been dealing with this for 22 months now, and despite these headwinds... the S&P 500 has shown a positive resilience not seen since late July."

The upside pressure for the stock market is in part driven by the fact that "interest rates are running out of reasons to relentlessly rise," he added, especially as several Fed members turn more dovish, balancing out Chair Jerome Powell's hawkish "higher for longer" speech at the September FOMC meeting.

"This cycle is all about breaking the back of inflation, not breaking the economy. And inflation was fueled by many supply dynamics that are ending. Thus, the sooner the Fed stops hiking, the sooner the earnings recovery can start," Lee said.

A combination of recovering earnings, a paused Fed, and a growing economy is a "bullish formula" for stocks, JPMorgan said earlier this week, and Lee appears to be on board.

Fundstrat technical analyst Mark Newton said the S&P 500 could rise 6% over the next month to its July high of 4,607, which "would be a violent and painful surge," Lee said. And such a rally would help set up the market for a test of Fundstrat's year-end S&P 500 price target of 4,825, which represents potential upside of 11% from current levels.