The recent multi-week downturn in the stock market, which commenced earlier this month, is likely approaching its conclusion, according to insights from Fundstrat’s Tom Lee. Lee, a perennial optimist on stocks, communicated to his clients this past Friday that the near 5% dip observed over the last three weeks primarily resulted from a de-leveraging episode that is poised to end soon. This setup, he notes, could catalyze a market rebound in the near term.
Lee observed, "Given the strong performance of equities in the first quarter of 2024, a phase of consolidation or mild decline isn't wholly unexpected. Our current perspective diverges in that we foresee no extended downturn looming."
The recent pullback in stocks has largely been fueled by a dual threat: disappointing inflation data and escalating geopolitical tensions in the Middle East. Nevertheless, Lee anticipates these factors will soon dissipate, clearing the path for equities to resume their upward trajectory and potentially set new record highs before year’s end.
Lee presents five key reasons supporting his view that the stock market decline is nearing its conclusion:
Stable VIX Levels: Lee finds reassurance in the behavior of the VIX, Wall Street’s barometer of fear, which has remained relatively stable during this period of market fluctuation. Despite a 7% jump on Friday, the VIX has stayed below the crucial risk-on/risk-off threshold of 20. Lee suggests that a VIX drop below 18 could signal a bullish turnaround for stock prices.
VIX Term Structure Normalization: Earlier this week, the VIX term structure inverted briefly before returning to normal. This rapid normalization implies a reduced probability of significant volatility in the near term. Lee recalls a similar pattern from March 2023, which preceded a significant rally lasting a year.
Acceleration of Market Losses: Counterintuitively, Lee views the recent acceleration in market losses as a potential indicator that the unwinding of investor leverage is almost complete. He notes that the S&P 500’s negative rate of change reaching 3.6% over five days—a scenario that has occurred seven times since October 2022—historically signaled an imminent rebound in five of those instances.
Elevated Put-to-Call Ratio: The put-to-call ratio, an indicator of market sentiment through options activity, has shown a predominant preference for bearish puts over bullish calls, with a recent ratio of 1.13. Historical data indicates that similar elevated readings typically marked a market low, with six out of seven occurrences since October 2022 indicating a turnaround.
Technical Indicators Suggest a Low: Citing Fundstrat’s technical strategist Mark Newton, Lee points out that despite the weakness in technology stocks, there has been no breach in their uptrend relative to the broader S&P 500. Additionally, a lack of strength in typically defensive sectors like consumer staples and REITs, alongside robust market breadth, suggests a potential market bottom could form as early as next week.
These indicators collectively lead Lee to believe that the market downturn is transient and a recovery is on the horizon, positioning savvy investors to capitalize on the impending upswing.
