This week's inflation report will spark a big rally in the stock market, Fundstrat says

• The Thursday release of the July CPI report should spark a sizable stock market rally, according to Fundstrat's Tom Lee.
• Core CPI is expected to be 0.22%, but Fundstrat expects the CPI report to undershoot at 0.15%.
• "The primary driver remains the drag in CPI coming from the fall in used car prices," Lee said.

Investors should expect a "sizable rally" in the stock market following the Thursday release of the July CPI report, according to Fundstrat's Tom lee.

Consensus estimates suggest Core CPI to be 0.22%, but Fundstrat's data science team estimates that inflation will undershoot to just 0.15%, which represents an annualized rate of 1.8%, just below the Federal Reserve's long-term inflation target of 2%.

Lee's bullish call is significant considering that just over a week ago, the Wall Street strategist warned investors of a short-term stock market sell-off due to poor seasonality in the month of August, combined with the flashing of a technical sell signal. Since that warning, the S&P 500 has declined by as much as 2.5%.

But the July CPI report could be the catalyst needed to spark a rebound in stock prices, as it could solidify the idea that the Fed is finished with its interest rate hiking cycle.

"We believe +0.15% would be a positive surprise versus consensus... The primary driver remains the drag in CPI coming from the fall in used car prices," Lee said. "In our view, this positive surprise would be more than enough to offset the 'tape bombs' that rattled markets on Tuesday."

Those "tape bombs" Lee referenced include Moody's downgrading a slew of regional banks due to the potential of a recession, as well as worrying economic data out of China that showed a return of deflation.

Lee believes a cooler-than-expected July CPI report would be more than enough for a stock market rally that recovers all of the losses since the start of the month. Such a rally would equate to at least a 2% move higher in the S&P 500.

Part of Lee's confidence in a cooler CPI report stems from the fact that since the end of 2019, auto and shelter prices accounted for 66% of the increase in inflation. But now those price increases in cars and shelter are moderating considerably.

"Investors overlook that used cars and housing are such outsized contributors to inflation. And as these components cool, the remaining components will not necessarily lead to a renewed surge in overall core inflation," Lee said.

Also helping the potential for a stock market rally following the July CPI report is the fact that investor sentiment has soured amid the one-week stock market decline.

"Investors seem to have already become far more wary and that is a good thing from a sentiment perspective. Equities seem oversold as well. So, we think the probability for stocks to rally strongly after CPI is very high," Lee said.