Tom Lee: Why a Midyear Market Pullback Is Likely
Audio Brief
Show transcript
This episode covers the stock market's strong start to the year, predicting significant mid-year volatility followed by a year-end recovery.
There are three key takeaways from this conversation.
First, prepare for significant volatility, with a strong market start potentially preceding a sharp mid-year correction before a year-end rebound. The January Barometer suggests a positive start, but experts forecast a mid-year drawdown that could feel like a bear market, driven by high valuations.
Second, diversify beyond big tech by exploring opportunities in sectors like energy, materials, and financials, as the market rally broadens. The current market breadth is encouraging, with strength in equal-weight S&P 500 components, indicating healthier, broader participation beyond large-cap tech.
Third, focus on earnings quality and growth, which remain the primary drivers of stock performance, particularly for justifying tech sector valuations. Macroeconomic tailwinds, including a more dovish Federal Reserve and reduced tariff uncertainty, support a positive outlook provided strong double-digit earnings growth persists.
This outlook emphasizes strategic preparation for market shifts and focused investment in growth.
Episode Overview
- A review of the stock market's strong start to the year, which is seen as a positive indicator for the remainder of the year.
- A forecast for the year's market trajectory, including an initial rally, a significant mid-year correction that could "feel like a bear market," followed by a rally to end the year.
- Discussion on the encouraging breadth of the market rally, with sectors like energy, materials, and financials performing well alongside tech.
- Analysis of macroeconomic tailwinds, such as a more dovish Federal Reserve and the potential for tariffs to be overturned or at least not increase.
Key Concepts
- January Barometer: The idea that the market's performance in the first week of January can be a predictor for the rest of the year.
- Mid-Year Drawdown: The expert predicts a significant market correction or potential bear market mid-year as the market digests gains and faces high valuations.
- Market Breadth: The rally is not solely driven by large-cap tech. The strength in the equal-weight S&P 500, financials, energy, and industrials indicates a broader, healthier market participation.
- Macroeconomic Tailwinds: Key factors supporting the market include reduced uncertainty around tariffs and a more dovish stance from the Federal Reserve, which is now focused on the job market rather than aggressively fighting inflation.
- Valuation vs. Earnings Growth: While market valuations (like the 22x P/E ratio) may seem high, they can be justified if earnings per share (EPS) growth remains strong, particularly in the tech sector.
Quotes
- At 00:37 - "I think there'll be a point this year where it's going to feel like a bear market." - Tom Lee explains his forecast for a significant correction or drawdown sometime during the year.
- At 03:35 - "Provided EPS growth remains positive, we do think that that estimates are overly optimistic, yet we still expect the S&P 500 to print double-digit earnings growth this year." - The host reads a Barclays note suggesting that current valuations are reasonable as long as earnings growth continues.
- At 05:33 - "100% agree because, let's say the S&P's earning growth is 16, well, you know, if something's growing 25 or 40%, you'd need a lot of P/E compression to underperform the S&P." - Tom Lee explains why he believes tech will continue to outperform, citing its superior earnings growth rate compared to the broader market.
Takeaways
- Prepare for significant volatility; a strong start to the year may be followed by a sharp mid-year correction before a potential year-end recovery.
- Diversify beyond big tech by looking for opportunities in sectors showing renewed strength, such as energy, materials, and financials, to capitalize on the market's broadening rally.
- Focus on earnings quality and growth, as this will be the primary driver of stock performance, especially for justifying higher valuations in the tech sector.
