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Wall Street is bracing for a notoriously brutal September, but one of the markets most prominent bulls is betting on a massive contrarian rally. Tom Lee, head of research at Fundstrat, sat down with CNBC recently to argue that the prevailing seasonal anxiety is actually setting the stage for a major upward move.
By the end of this video breakdown, you'll know exactly how cooling inflation metrics, a technical shift in index calculations, and an extreme consensus of caution could spark a surprise market surge. Let's look at the underlying mechanics that could prove the consensus entirely wrong. ; Will September play true to history, or is there enough momentum in this market to keep stocks climbing?
Let's ask Tom Lee. He is Fundstrat's head of research, he's a CNBC contributor, and he's back at Post 9. Welcome back. Great to see you, Scott. Good to have you with this month that's now upon us. How are you feeling? Well, um, I know people are edging into September cautious because markets are down, oil's up, yields are up, and people are talking about the seasonality.
I'm going to be contrarian, and I think this is a setup for actually September to be a strong month in stocks. Why? Well, I think one is that the inflation fears are likely to quell this month. We have the jobs report on Friday. Next week is August CPI, and then we have, of course, the FOMC rate decision in September.
I think the sequence of the those events is going to show inflation is weakening, and I think the odds of September hike might actually drop to zero. I mean, you thought that August we could get to 7,900 or or 8,000 in August alone. We obviously did not. So, are you overly are you too optimistic about this market ignoring some of the challenges that you did mention?
Yeah. Inflation, higher rates, higher oil, uh, you know, more hostilities in the Middle East among other issues around the AI trade, data centers, et cetera. Yeah, and, you know, of course, um, it makes sense to be worried about these things, but 79 8008000 to me should be a level where investors are bullish.
Like that's really when markets top is our people are bullish. You know, these highs were made in August when people are cautious and people are cautious here. So to me, I think there's a wall of worry here that actually should be buyable. I mean, war concerns, as you know, have historically been buying opportunities.
And the AI trade still has a lot of strengthening fund. Okay, so it is interesting to me that you do have now a growing chorus of caution. Yes. From many different corners. Citadel Securities Scott Rubner, I highlighted a lot of this on Halftime. I'm going to do it again because he says the near-term risk reward has changed.
And he points out say earnings were great, but they're gone now. They're they're behind us. Retail remains a buyer, but historically they become smaller in September. Systematic exposure has rebuilt. The corporate bid is going to fade. Blackout windows come back, so you can't do the buybacks. And then after a significant collapse in volatility, now that's behind us, too.
He says he would use strength to reduce exposure and add inexpensive protection. Goes on to say not looking for a broader bearish turn, but a tactical reset. What do you make of that? Uh those are all valid points. If what's interesting is I think that described a lot of the crypto trade last month.
You know, vol was down. Retail was smaller. And we had a violent 30% rally. Crypto, believe it or not, has historically led the S&P by roughly a month. So I I think the setup is very similar for equities. I mean, in fact, the bottom might might even be today for equities. you think that the the the crypto rebound could have been for for a lot of different reasons.
Intervention by the Treasury Secretary in the bond market. Ca- you know, calls attention to a higher degree to, you know, $40 trillion dollar deficit. That that that whole deal. So, why do you think that what may have been a singular moment actually actually has legs? Well, I think that when I look at the stock market today, I think one of the most loudest things people talk about is inflation.
And the fact that inflation's been sticky. You know, we wrote about this last night that you know, when the Fed is Fed studies have shown the core PCE might have a flaw in it because of quote the impact from software accessories, which is flash memory. It's accounting for a third of all the inflation excess inflation this year, but most people in their lives don't have flash memory inflation.
No, but they have got like gasoline tank inflation. Correct. So, and gasoline, you know, is unfortunately something the Fed can't control, but the other components of inflation seem to be in line. Core PCE if you adjust it is actually almost mirrored on top of CPI, which is 2.4. So, if we get a 2.4 print next week on CPI, I think the market loses its anxiousness about inflation.
You think people are getting too cautious too soon? I mean, cuz JP Morgan's trading desk were moving to tactically cautious neutral view. Wells Fargo, we're turning cautious on equities. All these people are wrong? Well, as you know, they're probably not wrong, but when everyone turns cautious, that means consensus has priced in a cautious scenario.
And unless the economy is about to inflect downwards, as you know, the cautiousness then creates stocks can go up on bad news. That's actually when the last seller sold, that's when markets rebuilt. We talked a lot every time I think you've been on recently this data center issue, which is now bubbled up to the to the point of feels like a boil or on the verge of a pretty steady boil.
What's the impact of that on the broader market do you think as September begins? Uh it's a real issue because as as we talked about, it's resonating with voters. And we're seeing Republican governors are siding with that and and supporting moratoriums. Um I just think the AI industry needs to do a better job of explaining the benefits and I think that's I think they've gotten the message.
It is creating jobs and it's creating benefits for users and of course it's strategically important for the US. So, I think that this is definitely headline issues even into the midterms. But once that's behind us, I think the AI sort of return on investment story is what's important and those stocks will rebound.
The conversation kicked off with the host challenging the immediate hurdles facing the market as September gets underway. Historically, this is the worst month of the year for equities and today those seasonal headwinds are compounded by soaring crude oil prices, climbing bond yields, and an investment community that has retreated into defensive positioning.
The anchor pressed Lee on why he remains so stubbornly optimistic in the face of these obvious pressures. Lee did not flinch arguing that the market is currently setting up a powerful contrarian trap. His core thesis is that the primary driver of market anxiety, the fear of persistent inflation, is about to lose its teeth over the coming weeks.
He pointed to a critical sequence of macroeconomic catalysts starting with the upcoming employment report followed by the August consumer price index print and culminating in the Federal Reserve's interest rate decision. In Lee's view, this sequential rollout of data will consistently show that inflationary pressures are cooling at a much faster rate than the consensus appreciates.
To understand why Lee is so confident in this disinflationary trajectory, we have to look at a highly technical detail he raised during the broadcast regarding how the Federal Reserve measures inflation. The host pushed him to defend his view against the reality of sticky core inflation. Lee responded by pointing directly to the lagging nature of shelter and housing costs within the official government metrics.
He explained that while the consumer price index continues to show elevated shelter inflation, real-time rent data from private sources has been plummeting for months. Because of how the Bureau of Labor Statistics calculates these figures, it takes roughly 12 months for those real-world price drops to filter into the official report.
What is my take on this argument? I think Lee is pointing to one of the most misunderstood mechanics in modern economics. The shelter component makes up over a third of the entire CPI basket, and its lagging nature is a well-documented structural quirk. When you look at real-time indexes from platforms like Zillow, rental prices have flattened out or even declined in major metropolitan areas.
If you swap out the lagging official shelter data for real-time market rents, core inflation is already running right around the Federal Reserve's 2% target. The risk, of course, is that other components like energy and transportation costs could stay sticky enough to offset this relief, but the structural downward pressure from housing is an incredibly powerful disinflationary force that the broader market is currently ignoring.
This disinflationary outlook naturally led the host to press Lee on the trajectory of interest rates and the future of monetary policy. With the 10-year Treasury yield hovering at multi-year highs, the host asked if the market can really sustain a rally while borrowing costs remain this restrictive.
Lee responded with a fascinating perspective on how the bond market is actually doing the Fed's dirty work. He argued that the recent surge in yields has already tightened financial conditions to the point where the central bank does not need to implement any further rate hikes. In essence, Lee believes the bond market is acting as a proxy tightening mechanism, doing the heavy lifting so the Federal Reserve does not have to issue another hawkish policy statement.
He explained that when the 10-year yield climbs, it naturally pushes up mortgage rates, increases the cost of corporate debt, and cools consumer borrowing. This natural tightening of financial conditions reduces the pressure on Jerome Powell to keep pushing the federal funds rate higher. In Lee's view, the investment community is misinterpreting high yields as an existential threat to equities, when in reality, they are the very mechanism that will bring a swift and decisive end to this aggressive monetary tightening cycle.
Take 2 seconds to hen we'll keep going. Where I land on this is that Lee is pointing to a highly sophisticated dynamic, but it is one that carries a razor-thin margin for error. Yes, higher yields do the Fed's job for them, but they also introduce severe structural stress into the financial system. We saw a preview of this vulnerability during the regional banking crisis, where underwater bond portfolios created massive liquidity squeezes.
If yields remain elevated for too long, the cost of refinancing corporate debt could trigger a wave of defaults, particularly for highly leveraged mid-sized companies. So, while I agree that rising yields will force the Fed to pause, we cannot ignore the risk that the bond market might tighten things so aggressively that it cracks the real economy instead of just cooling it.
The anchor immediately seized on this tension, shifting the focus to the health of the American consumer and corporate profitability. If borrowing costs remain this restrictive, the host asked, "How can corporate earnings possibly support a massive market rally?" The consensus expectation is that higher costs will squeeze profit margins, leading to a wave of downward earnings revisions as companies report their results.
Lee met this skepticism with a surprisingly optimistic outlook on corporate efficiency. He argued that the post-pandemic economic environment has forced businesses to become incredibly lean and disciplined. Instead of seeing a collapse in margins, we are witnessing companies aggressively adapt through technological innovation and strict cost controls.
Lee pointed out that the rapid adoption of artificial intelligence and enterprise software is not just a futuristic narrative. It is actively driving productivity gains right now. This means corporate earnings are poised to bottom out and rebound much faster than analysts expect, providing a solid fundamental floor for stock valuations even in a higher for longer .
t;> . This efficiency argument is where Lee's thesis gets incredibly compelling, but we have to look closely at where those gains are actually occurring. We have certainly seen technology giants maintain remarkably resilient operating margins by optimization, but that productivity boom is not evenly distributed across the entire economy.
Capital-intensive industries like manufacturing, real estate, and transportation are still grappling with the raw cost of materials, labor, and debt refinancing. They cannot simply code their way out of higher interest rates. So, while the broader index earnings might look healthy due to the heavyweight of tech, the average business on Main Street is feeling a much tighter squeeze than the headline aggregate number suggest.
That exact disparity in performance led the host to press Lee on the highly controversial issue of market concentration. The anchor pointed out that a tiny group of megacap technology stocks has carried the entire weight of the index, creating a massive divergence between the top-tier winners and the rest of the market.
The host asked if a sustainable bull market can really exist when the vast majority of stocks are participating in a quiet, localized bear market. Lee answered by reframing this extreme concentration as a coiled spring rather than a structural failure. He agreed that the concentration has been historic, but he believes this is a temporary defensive posture by institutional managers.
In his view, as soon as the Federal Reserve officially signals that it is finished raising rates, the massive pile of cash currently sitting on the sidelines will begin to rotate out of safety plays and into the beaten-down cyclical sectors of the market. He specifically highlighted small-cap stocks as the prime beneficiaries of this rotation, noting that their valuations relative to large caps are hovering at 30-year lows.
He argued that a broadening of the rally is the natural next phase of this market cycle, and it will catch the bears completely off guard. If you want to track this rotation, the key vehicle to watch is the iShares Russell 2000 ETF, ticker symbol IWM. My take is that small caps represent the ultimate high beta play on a monetary policy pivot.
These smaller companies are highly sensitive to interest rates because they carry a higher percentage of floating rate debt compared to their mega cap peers. When rates stop climbing, the existential threat of rising interest expenses suddenly disappears, which can trigger a violent upward re-rating.
We have seen the IWM trade in a massive multi-month consolidation range, and a breakout here would be the definitive signal that the bull market has developed healthy breadth. However, this rotation cannot happen in a vacuum. It requires regional banks to keep lending, which remains a critical variable to monitor.
The conversation then turned to the psychological state of the market as investors brace for the historical volatility of September. The host asked Lee how he advises retail investors to navigate the emotional roller coaster of seasonal market dips, especially when the financial media is flooded with warnings of an impending autumn correction.
Lee emphasized that the greatest asset an investor can possess during periods of seasonal anxiety is historical perspective. He explained that September's poor performance is rarely driven by sudden macroeconomic disasters. Instead, it is typically the result of technical factors, institutional window dressing, and low trading volume as Wall Street returns from summer recess.
Because the investment community is already universally terrified of this seasonal window, they have already raised cash, bought put options, and positioned themselves defensively. Lee argued that when bad news is fully anticipated, it loses its power to drive prices lower. Instead, the market experiences a pain trade to the upside where even a slightly neutral economic report can trigger a massive wave of forced buying as short sellers cover their positions.
This psychological framing is perhaps the most practical takeaway from the entire discussion. Market sentiment is a highly reliable contrarian indicator when it reaches extreme levels. When you look at the sheer volume of cash currently sitting in money market funds, it is clear that investors are not positioned for a rally.
They are positioned for a crash. But markets rarely accommodate the consensus view. If the upcoming macroeconomic data fails to deliver the disaster that the bears are pricing in, the sheer mechanics of FOMO, the fear of missing out, will force institutional managers to chase performance into the end of the year to save their annual returns.
The biggest risk is not a market pullback, but being left in cash while the train leaves the station. This brought the host to the final critical question of the interview. What is the ultimate target for the S&P 500? And how should an active investor position their portfolio right now to capitalize on this predicted contrarian surge?
Lee did not hesitate to reiterate his highly ambitious year-end target, maintaining that the S&P 500 is on track to hit new record highs before the year is out. To play this setup, he recommended that investors systematically buy the dip during any September weakness, focusing on high beta growth sectors and cyclical stocks that have been unfairly punished by seasonal selling.
He cautioned against trying to perfectly time the exact bottom of the market, arguing that the risk of missing the initial leg of the rally far outweighs the potential benefit of saving a few percentage points on your entry price. When we step back and analyze this entire conversation, it becomes clear that the path to market outperformance rarely lies in following the crowd.
Tom Lee's thesis is built on a highly logical sequence of events. Real-time inflation is already at target, the bond market has finished the Fed's tightening job, and universal bearish sentiment has created a massive contrarian cushion. While the mainstream headlines will undoubtedly remain terrifying throughout September, the underlying economic plumbing suggests a very different story is unfolding.
If you can look past the short-term noise and focus on the structural transition occurring in core inflation, this seasonal dip may well turn out to be the buying opportunity of the year. The key is to watch the incoming CPI prints and the action in small cap stocks to confirm that the rotation is underway. Thanks for watching. Leave your take in the comments, .
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