The stock market is headed for a critical week ahead of the Fed meeting, CPI

• Next week is an important one for the stock market as investors prepare for CPI data and the Federal Reserve meeting.
• Fundstrat chief Tom Lee said the low inflation reading could boost stocks as it would encourage a pause in the Fed’s interest rate hikes.
• “Our view remains that inflation is lower than consensus,” Lee said.

Next week is one of the most critical weeks of the year for the stock market as investors prepare for the Federal Reserve’s interest rate decision, which could put a pause on interest rate hikes and new CPI data.

Tom Lee, head of research at Fundstrat, said that as stocks enter new bullish mode, the market could be jolted by volatility depending on how new inflation data shakes out and how the Fed responds to that data in its June 13-14 policy meeting. during the meeting.

With market consensus expecting core monthly inflation to come in at 0.4% for May, investors would be surprised if inflation came in closer to 0.3%. That would be a positive surprise, as it would strengthen the Fed’s potential decision to hold off on raising interest rates this month and into July.

“If May Core CPI [is less than] 0.4%, then we see these ratios [of interest rate hikes] drops to zero for each month,” Lee said in a Friday note.

Lee is confident that inflation is indeed lower than the consensus based on real-time CPI measurements, and that inflation is actually approaching the Fed’s long-term goal of 2%.

“If that happens, the Fed’s pause will turn into a data-driven mode where the bar is raised further [interest rate] “We expect investors to see this as a green light for risk assets, meaning equity investors won’t be fighting the Fed.”

But if the Fed goes ahead with raising rates again, investors should be ready to buy the potential downside in stocks, according to Lee.

“Even if the Fed raises rates a few more times in 2023, what matters to us is whether it’s in response to rising inflationary pressures.” And our view is that those pressures are coming down,” Lee said.

Bolstering Lee’s bullish case is the fact that market width is starting to widen, which is a healthy sign for the current rally’s sustainability. In other words, more and more stocks are starting to participate in the rally, rather than the rally being driven by just a few mega-cap tech stocks.

“The breadth of the market is improving markedly,” Lee said, pointing to the outperformance of small-cap stocks this week. “Still looking to buy dips as market width widens.”

Lee continues to advise investors to remain overweight in the industrial and regional banks sectors, and he reiterated his 2023 year-end S&P 500 price target of 4,750, representing a potential upside of 10% from current levels.