The rally in stocks won't be swayed by a hawkish Powell, as falling inflation still points to a 20% gain for the market this year, Fundstrat says

• Stocks are still set for a 20% gain this year thanks to falling inflation, Fundstrat's Tom Lee said.
• Lee made the case for a rally despite Powell's hawkish testimony before Congress on Tuesday.
• Markets are expecting higher rates, but inflation expectations haven't changed, which is good news for stocks.

The rally in stocks isn't going to be derailed by a hawkish Federal Reserve, as falling inflation still points to a 20% gain for the market this year, according to Fundstrat's head of research Tom Lee.

In a note on Wednesday, Lee reiterated his bullish view on stocks despite Fed Chairman Jerome Powell's hawkish testimony before Congress on Tuesday. The top central banker warned that rates would likely need to keep rising, causing investors to raise their expectations for a 50 basis-point rate hike in March and spurring a sell-off in stocks.

Already, central bankers have raised interest rates 450 basis-points to tackle rising inflation, a move that weighed heavily on stocks last year and sent the S&P 500 lower 20%. 

But the hawkish comments haven't changed the overall trajectory of stocks this year, Lee said, as inflation is still coming down, which matters more for equities.

"This testimony is not really changing anything as the Fed actual path is a function of what happens with inflation," Lee said. "The forward path of inflation, of course, is not yet known but the leading indicators show future progress is in the works."

Fed officials have flashed hawkish signals after seeing hot inflation indicators in January, such as new payrolls, which beat economists' expectations. But that data is likely distorted due to lags in the official statistics, Lee said. More timely figures, such as data from job listing sites like Linkup and Indeed, show around one million fewer job openings than the official jobs report – a sign the economy is already starting to cool off from the Fed's aggressive monetary policy.

Meanwhile, six and 12-month inflation expectations actually fell after Powell's testimony, a sign markets are still expecting inflation to continue on its downward path. 

Falling inflation should quell market volatility, which has historically led to positive returns for stocks, Lee said. He predicted the CBOE Volatility Index to trend below 20 this year, which could cause stocks to gain another 20% from current levels.

Lee has been bullish on equities for months, and previously predicted the S&P 500 to retest an all-time-high in 2022, though the stock index actually closed the year 20% lower. He made the case that stocks could see their strongest rally of the year through March and April, and urged investors to buy the dip in equities.