Fundstrat lays out the scenario that would ruin its call for a 6% S&P 500 rally into year-end

Traders on the floor of the New York Stock Exchange May 31,2019 in New York. - Wall Street stocks closed out a downcast May on an especially negative note on Friday, falling hard after President Donald Trump announced new tariff measures on Mexico. Major indices were in the red the entire session after Trump unveiled his latest trade broadside on Twitter Thursday night, vowing a string of gradual tariff increases to pressure Mexico into cracking down on illegal immigration into the United States. (Photo by Don Emmert / AFP) (Photo credit should read DON EMMERT/AFP via Getty Images)

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• Fundstrat's Tom Lee expects the S&P 500 to rally 6% by year-end, according to a Monday note.
• Lee points to de-risking among investors as evidence that a lot of bad news is already priced in.
• There is one possible scenario that would derail Lee's expectations of a year-end rally in stocks.

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The Omicron variant of COVID-19 and Fed Chairman Jerome Powell's hawkish pivot last week are two risks that have investors on edge, with the S&P 500 falling about 5% in a week.

But according to Fundstrat's Tom Lee, much of the concern surrounding these two factors are already priced into markets, evidenced by a surge in de-leveraging among institutional money managers over the past few days.

"Hedge funds have dramatically de-risked on the dual risks of Omicron and Fed tapering," Lee said, explaining that institutional investors have raised cash in each of the last 5 weeks and institutional cash on the sidelines now sits at more than $3.2 trillion, the highest level in all of 2021.

"Cash on sidelines = firepower. Sign of a bottom, not a top," Lee said. But while Lee still expects the S&P 500 to surge 6% to 4,800 by year-end, there is one potential, though unlikely, scenario that could derail that projection, according to the note.

The "bad" scenario is Omicron turning out to be more lethal than anecdotal evidence suggests, combined with the Fed remaining hawkish and not walking-back prior comments to a more dovish stance.

Admittedly, this scenario only has a 2.5% cumulative probability, according to Lee, because the Fed is likely to become more dovish if Omicron does infact turn into a deadly threat that evades vaccines and shatters consumer confidence.

The more likely scenarios seen by Fundstrat is Omicron being a milder variant of COVID-19, and the Fed remaining either hawkish or pivoting back to a dovish stance. According to Lee, stocks can still rise in the face of a Fed that is rolling back its monthly bond purchases at an accelerated pace because interest rates are still historically low and the economy remains on strong footing. 

"While there was a lot of carnage in the past few weeks, this does not negate the probability of a strong equity rally into year-end. That remains our base case," Lee concluded.

Fundstrat

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