Wall Street is more hawkish than the Fed and that suggests continued upside for stocks as sentiment improves, Fundstrat says

• A bullish counter trade is forming as Wall Street gets more hawkish than the Fed, according to Fundstrat's Tom Lee.
• Lee highlighted that economists expect the Fed to raise interest rates through 2023 to 5%.
• Meanwhile, only one Wall Street bank sees positive gains for the S&P 500 in 2022.

Wall Street has turned more hawkish than the Federal Reserve when it comes to interest rate hikes, and that sets up a bullish counter trade for stock market investors, according to Fundstrat's Tom Lee.

In a Friday note, Lee highlighted the fact that sell side economists expects the Fed to continue hiking interest rates through 2023 to as high as 5%. That's well ahead of Fed expectations, and it doesn't account for the reality that recent data shows inflation is cooling off in a big way.

Oil prices have been on the decline for two months, CPI in July fell below expectations, and July import prices saw its biggest decline since April 2020. Lee expects the decline in inflation to continue throughout the second half of the year, and that should give the Fed more flexibility in its interest rate hike trajectory.

"Leading indicators for inflation have shown the underlying trend in inflation was substantially lower than the 'hard' data [like CPI reports]," Lee said.

And if inflation continues to fall, Wall Street is too hawkish. "If the sell side is more hawkish than [the] Fed and inflation markets it makes sense to 'fade' that," Lee said.

Additionally, Wall Street banks are "outright bearish" on the stock market heading into the end of the year, which is another trade investors should fade, according to Lee, who believes the S&P 500 could reach new highs by the end of 2022.

Looking at year-end S&P 500 price targets from Wall Street banks, Lee found that nine out of 15 banks are bearish, with expectations that stocks see less upside than two-year bonds.

Six of those bearish Wall Street banks expect stocks to fall from current levels into year-end, with one forecast suggesting that the S&P 500 could fall to new lows at 3,600, representing potential downside of 15% from current levels.

Meanwhile, only one Wall Street bank expects positive gains for the S&P 500 in 2022, with JPMorgan setting a 4,900 year-end price target for the S&P 500.

With inflation cooling, and a majority of Wall Street bearish on the outlook for stocks, Lee suggests investors take the other side of that bet and go long stocks into year-end.

"We believe the S&P 500 will see a recovery similar to 1982 and thus, recover YTD losses before year-end," Lee said.

Bolstering Lee's view is the recent expansion in stock market breadth, or participation, amid the ongoing recovery from the mid-June low.

"The advance/decline line is breaking to the upside, [and] small-caps relative performance is breaking out to the upside," Lee said. "These are both solid measures of market breadth and show the rally in stocks is broadening. This lends further credence to the rally."