Bad news is good news for the stock market as investors look for an end to the highest inflation in 40 years, Fundstrat says

According to a Monday note from Fundstrat's Tom Lee, the stock market is set up to view bad economic news as good news as investors seek an end to 40-year highs in inflation.

The Federal Reserve has been forced to raise interest rates and reduce its balance sheet because of high inflation readings. Supply-side disruptions that are not influenced by the Fed's monetary actions are driving much of the inflation in everything from oil to eggs.

If inflation starts to fall, it will give the Fed more breathing room in its current tightening cycle, which could lead to a huge rally in risk assets like stocks.

The job market could be cooling at a faster pace than was implied by the tighter financial conditions, he said.

Wage inflation is one of the main drivers of inflation, and a cooling labor market should help limit wage inflation. There are 1.9 job openings for every unemployed American, but the data is on a six-week delay.

Job postings on Indeed.com have been cooling off in the past month, along with a surge in layoffs at startup companies. The decline in new job postings for the healthcare, retail, and leisure sectors will likely show up in the next release of JOLTS data, giving investors confidence that a less strong labor market will help limit wage inflation.

According to Indeed.com data, job postings have slowed down as travel searches have decreased over the past month. Lee explained that this could slow the need for hiring.

According to data from Layoffs.fyi, layoffs at startup firms have risen to the highest level since May 2020 as the cost of capital increases.

Layoffs are increasing, hitting 7,700 so far in May, and we expect this to soon go parabolic, based upon anecdotal comments we have heard.

With alternative, up-to-date data showing a swift slowdown in the labor market, that could help subdue wage inflation and lead to an overall cooldown in the high inflation readings investors have gotten used to over the past few months. That could lead to a relief rally in the stock market, which has been hammered by concerns of rising interest rates and high inflation.

Lee said he is bullish on stocks in the second half of the year after what has been a difficult start to the year for investors.