Central bankers will want to support stocks, according to Fundstrat's Tom Lee.
That's because the Fed wants a "healthy economy," a big component of which is a strong stock market, he said.
Rate cuts have been historically positive for stocks, leading to an average six-month gain of 13%.
The "Fed put" is back, and stock investors may not be fully pricing in the good news, according to Fundstrat's head of research Tom Lee.
The prominent stock bull pointed to the idea that central bankers could move to further ease monetary policy at any sign of weakness in the stock market. That notion had been dashed over the past two years, as the Fed aggressively hiked interest rates to control inflation.
Yet, a supportive environment for stocks could be high on central bankers' agendas again as they prepare for what is likely to be the first rate cut since 2020, Lee said in a note on Wednesday.
"Foremost, the Fed 'put' is back. That means the Fed's mandate is now primarily supporting a strong labor market," Lee wrote, pointing to fears that more jobs weakness could signal an oncoming recession. "That means the Fed wants a healthy economy."
A healthy economy, though, hinges on consumer and business confidence, which is largely tied to the stock market, Lee said. Even if stocks were to see a 10% correction, businesses could become more cautious, he said, suggesting they could lay off more workers.
A 30% stock decline would "almost guarantee" a recession due to the impact on the job market and household wealth, Lee added.
"We think the Fed does not want the S&P 500 to falter," he said. "The Fed in 2022 probably found the 27% decline of stocks as supporting their attempt to control inflation and manage inflation expectations. This is not the case any longer."
A supportive central bank is majorly bullish for stocks, but investors probably haven't priced that in yet, Lee said, predicting more upside on the way for equities.
Stocks have historically reacted well to Fed rate cuts. Since 1971, the first Fed cut has led to positive returns for investors 100% of the time in the next six months, with an average gain of 13%.
There's also room for a "positive surprise" in stocks, Lee said, given that some investors believe the economy is already in a recession, a point Lee disagrees with.
GDP growth has been stable, but three out of five Americans believe the US is already in a downturn, according to a survey conducted by Affirm.
Finally, rate cuts are likely to boost durable goods, auto sales, and housing sales, which should bolster the broader economy, Lee said.
"Keep in mind the Fed is dovish and there is a focus on keeping labor markets strong. We could be seeing turbulence for the next 8 weeks, but this is also in the context of a very strong stock market in 2024," he added.
The Fed will announce its rate decision at 2 p.m. ET on Wednesday. Investors see 100% odds of a cut but are split on how big it will be, pricing in a 65% chance the Fed could trim rates by 50 basis points, according to the CME FedWatch tool.
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