Election Uncertainty Within the Market
3 Key Reasons Point to a Strong Stock Market Rally
How the Election Will Drive the Market
As the 2024 U.S. Presidential election looms, the stock market faces a mixture of optimism and caution. However, Tom Lee of Fundstrat argues that investors should remain bullish, with the market poised to finish the year on a strong note. In his recent note to clients, Lee identified three key reasons for expecting a continued rally in the coming months: declining margin debt, a dovish Federal Reserve, and historical performance patterns that favor the bulls.
1. Declining Margin Debt Shows More Upside Potential
One of the most significant indicators supporting Lee's bullish outlook is the recent decline in FINRA margin debt. Margin debt measures the amount of money borrowed by investors to purchase stocks, and its movement often mirrors the broader stock market. In August 2024, margin debt fell to $797 billion, significantly lower than the October 2021 peak of $936 billion.
Lee believes this drop in margin debt is critical because, historically, stock market tops only occur once margin debt begins to roll over substantially. In other words, while margin debt is decreasing, it hasn't yet hit levels that typically precede market downturns. According to Lee, this suggests that there is still "firepower" left in the system—meaning investors still have room to increase their leverage, which could push stock prices higher.
In fact, Lee emphasized that past market peaks were only seen after margin debt started to decline dramatically, something that hasn’t yet occurred. This indicates that the stock market still has the potential to rise, as investors could continue to borrow more to invest in equities.
2. A Dovish Federal Reserve Boosts Stocks
Another driving force behind Lee's optimistic view is the Federal Reserve's recent pivot toward a dovish monetary policy. The central bank has signaled its willingness to cut interest rates, creating a favorable environment for stocks. When the Fed cuts rates, borrowing becomes cheaper, which encourages both businesses and consumers to invest and spend more. This, in turn, tends to boost corporate earnings and stock prices.
Lee analyzed market data from 1971 onward and found that when the Fed cuts rates while the economy remains strong, stock markets have consistently posted positive returns. Specifically, Lee identified seven instances of rate cuts where the economy didn’t experience a recession, often referred to as a "no landing" scenario. In each of these cases, the stock market delivered 100% win ratios for both three-month and six-month forward returns. On average, stocks gained 8% over three months and 13% over six months following such rate cuts.
This historical precedent, combined with the current dovish stance of the Fed, bodes well for continued gains in the stock market. Investors, Lee notes, should adhere to the old adage: "Don’t fight the Fed"—especially when monetary policy is aligned to support economic growth and financial markets.
3. Second-Half Rally After Strong First Half
Lee’s final point of optimism comes from the historical patterns of the S&P 500. In the first half of 2024, the S&P 500 surged 14%, driven by strong corporate earnings, improving economic data, and favorable monetary policy. Historically, when the S&P 500 posts a gain of 10% or more in the first half of the year, the second half often continues to show strong performance.
Lee’s data reveals that since 1950, the S&P 500 has delivered an average second-half gain of 9.8% in such scenarios, with an 83% win ratio. This means that in more than 80% of cases, the market continues to rise after a strong first half. The only notable exceptions were during the hawkish years of Federal Reserve Chair Paul Volcker, when high interest rates were used to combat inflation, resulting in market underperformance. However, with the current dovish Fed approach, Lee expects this historical trend to hold true, further supporting his year-end rally thesis.
In addition to these historical trends, Lee points out that the stock market often performs well in the months leading up to an election, as investors price in potential policy outcomes. Though the 2024 Presidential election introduces some uncertainty, the backdrop of falling inflation and a supportive Fed creates an environment where stocks can continue to rally.
Other Factors Supporting the Rally
In addition to these three core points, other factors are contributing to the favorable outlook for stocks through year-end:
Corporate Earnings Resilience: Despite a challenging macroeconomic environment earlier in the year, corporate earnings have remained robust. Many sectors, especially technology, have outperformed expectations, driven by continued demand and innovation.
Strong Economic Data: Recent reports on the U.S. economy, including job market strength and consumer spending, have provided further support for the bullish case. Although some sectors, like housing, have shown signs of cooling, overall economic activity remains healthy.
Investor Sentiment: Investor sentiment, while cautious due to the election, remains broadly optimistic. Many traders have adopted a "buy-the-dip" mentality, believing that any short-term volatility will be met with buying opportunities, particularly in the tech and energy sectors.
Conclusion: Stay Constructive and Focus on Upside
Tom Lee’s message to investors is clear: despite the potential uncertainties surrounding the Presidential election, the stock market is poised for further gains through the end of the year. With margin debt levels suggesting more upside, a dovish Federal Reserve providing a tailwind, and historical patterns favoring a strong second half, Lee encourages investors to "stay on target" and remain bullish.
As Lee emphasizes, the combination of these factors creates a favorable environment for stocks to continue rallying into December. While short-term volatility is always a risk, especially with the election approaching, the broader market outlook remains positive. Investors, Lee argues, should focus on the long-term upside and take advantage of the opportunities presented by the current market dynamics.