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A prolonged sell-off in the stock market is unlikely for these 2 reasons, according to Fundstrat's Tom Lee

Business Insider logo Business Insider 7/19/2021 mfox@businessinsider.com (Matthew Fox)
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  • A prolonged sell-off in the stock market is unlikely for 2 key reasons, Fundstrat's Tom Lee said in a note on Monday.
  • Recent weakness in stocks can be largely attributed to rising COVID-19 cases, according to Lee.
  • "July chop ultimately a great set-up for risk assets to rally in 2H2021," Lee said.
  • Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

Recent weakness in the stock market will likely be short-lived and won't extend into a large decline for two key reasons, Fundstrat's Tom Lee said in a note on Monday.

The stock market saw a steep drop to start this week, but Lee is maintaining a bullish outlook on steady bond yield spreads and a stable VIX term structure, according to the note.

Bond yields being stable relative to Treasuries is a positive signal for stocks, while the VIX term structure usually inverts when a correction looms. Right now, the VIX term structure, which is the difference between four-month and 1-month VIX contracts, remains flat, according to Lee.

As of Monday morning, the S&P 500 is down nearly 3% from its record high. According to Lee, the decline is tied to the recent uptick in daily COVID-19 cases due to the fast-spreading Delta variant among unvaccinated individuals.


Video: Stocks sell off heading into the close (CNBC)

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But the rising COVID-19 cases represent more bark than bite, according to Lee, who doesn't expect the decline in stocks to extend into a meaningful sell-off.

"We don't expect this period of chop to lead to a larger 10%-like decline for markets. Sure, a 3%-5% sell-off, even to S&P 500 4,100 is possible," Lee said.

Read more: Goldman Sachs says to buy these 25 stocks with high pricing power as executives warn of elevated and potentially persistent inflation on earnings calls

Instead, Lee expects the current weakness in stocks to ultimately be "a great set-up for risk assets to rally" in the second half of 2021, especially as the ongoing rise in COVID-19 cases likely peaks sometime in August, according to the note.

"If India saw cases peak within 4-6 weeks from initial surge, we expect USA, UK and Israel to see similar trajectories," Lee explained.

To take advantage of the potential rally in stocks later this year, Lee suggests investors focus on buying epicenter stocks that are poised to benefit from the ongoing reopening of the economy, as well as mega-cap tech stocks.

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