Wall Street bull sees stocks rally in 2023, but AI won’t be the only driver

One of Wall Street’s most bullish strategists sees the S&P 500 hit new record highs in the second half of 2023. But unlike the many strategists who have pointed to AI as the driver for stocks for the rest of 2023, Fundstrat’s Tom Lee sees things differently.

Lee singled out AI as an “engine for equity history,” also highlighting falling inflation, an economy unlikely to go into recession, and investors with cash stacked up and ready to buy stocks as top reasons to be optimistic on shares.

Fundstrat raised its full-year S&P 500 price target from 4,750 to 4,825 on Monday in its mid-year forecast for 2023, with Lee noting that a new bull market is taking hold.

“I know this sounds counterintuitive since we haven’t had any ‘recession’ or ‘Fed rate cut’,” Lee wrote, “but we have had a huge drop in inflation and, as we have argued for most of 2022 , the inflation war is the war the Fed is betting on and apparently winning.”

Lee’s note came days after new data showed the leading index of personal consumption spending rose 4.6% in May. While it is still well above the Federal Reserve’s 2% target, it has also marked a significant decline since inflation peaked above 9% just a year ago.

The research also follows a historically strong start to the year for stocks, which Lee himself predicted. AI-focused hype drove the Nasdaq Composite (^IXIC) up more than 31%, while the S&P 500 (^GSPC) soared more than 15% in the first six months of the year.

The Nasdaq rally marked the best start to the year for the tech index since 1983, according to data from Bespoke Investment Group. And as Yahoo Finance’s Jared Blikre recently noted, such first-half rallies are usually a good sign for year-ending stocks as well.

“By the way, +8% in 2H23 is the low end of what can be expected,” wrote Lee. “Of the 9 times (since 1950) the S&P 500 had gains >10% in the first half AND was negative the prior year, the average gain was +12%.”

A 12% increase in the S&P 500 over the next six months would see the index end the year around 5,000.

Lee noted that the forward price-earnings ratio of the S&P 500 excluding FAANG shares rose just 0.7%, despite a roughly 16% rally in the index earlier in the year. This could indicate that while some stocks outside of tech stocks have joined the rally, more may soon be on the way as well.

Lee added, “Cyclicals should lead if financial conditions are easing,” and continues to support technology, industrials and energy stocks.

NEW YORK, NEW YORK - MAY 05: People pose by the Wall Street Bull near the New York Stock Exchange (NYSE) on May 05, 2022 in New York City.  The Dow Jones Industrial Average is down more than 1000 points as inflation fears continue to worry investors.  (Photo by Spencer Platt/Getty Images)

NEW YORK, NEW YORK – MAY 05: People pose by the Wall Street Bull near the New York Stock Exchange (NYSE) on May 05, 2022 in New York City.

“A buy the dip scheme”

As Lee often does, he admitted he’s one of the most bullish strategists out there and expects “a lot of pushback from the consensus.” This continued to play out in the latest Bank of America Sell-Side Indicator data revealed on Wednesday.

The indicator, which tracks the recommended average allocation to equities by US sell-side strategists, rose 33 basis points to 52.9% in June. This is the largest monthly increase since November 2022, but still bearish by historical averages. Even with a rally to start the year, the gauge is still 1.6 percentage points lower than where it started the year.

Interestingly, however, BofA views the Sell-Side indicator as a contrarian indicator, meaning that strategists’ current bearish positioning is usually a good sign for stocks. The current SSI reading points to a 16% rise in stocks over the next 12 months, which would take the S&P 500 to 4,800 at the end of the year and 5,200 in one year, wrote Savita Subramanian, head of US equity and quant strategy at BofA.

So even if others remain bearish, Lee sides with history and remains bullish on stocks.

“Be prepared for volatility,” Lee wrote. “But as we highlighted a few months ago, we’ve entered a ‘buy the dip’ regime, so 2% pullbacks are generally buyable. We saw that on display last week.”

Josh is a reporter for Yahoo Finance.

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