A bullish trifecta of stock market indicators is flashing, and it suggests a 20% rally is on the horizon, Fundstrat's Tom Lee says

• There are three stock market indicators that are flashing a bullish signal, according to Fundstrat's Tom Lee.
• Lee pointed to the uptick in market breadth, a measure of winning stocks, in three separate gauges of the S&P 500.
• When those indicators flash simultaneously, it's a reliable sign of a future rally, and stocks could gain 20% this year, he said.

A bullish trifecta of stock market indicators are flashing, and it's a reliable signal that a 20% rally in stocks could be on the horizon, according to Fundstrat's head of research Tom Lee.

Lee pointed to the surge in market breadth in the S&P 500, a measure of how many stocks are gaining at once. In particular, there are three separate breadth gauges are showing an uptick in winning stocks: the Whaley Breadth Thrust, the Walter Deemer Breakaway Momentum, the Triple 70 Thrust.

These technical gauges have good track records in predicting a major rally in stocks, especially when they occur simultaneously. When at least two of those gauges are showing rising market breadth, the S&P 500 gains on average 24% over the next year, according to Fundstrat.

But the current market shows an even more positive outlook, since all three indicators are flashing. It's the only time all three breadth indicators have flashed since 1970 – an "unprecedented trifecta," market research firm Quantifiable Edges said in a recent note.

And it's a strong suggestion that a huge rally could be in the works, particularly as inflation eases and the Federal Reserve begins to pull back on its monetary tightening efforts.

"The recovery in market breadth is a sign that demand for equities is recovering. We know investors are not 'risk-on' coming in 2023," Lee said. "This all supports stocks strengthening in 2023."

Lee has said he believes investors are in for at least a 20% rally in the S&P 500 this year, as it's uncommon for the S&P 500 to have flat or negative returns after a losing the previous year. Since 1950, the stock index has risen more than 20% after a negative year 53% of the time. Inflation, a major headwind for stocks in 2022, has also cooled from a 41-year-record, suggesting the Fed can hit pause on raising interest rates, and possibly even start cutting in 2023. 

"We think 2023 is arguably more akin to 1982, when stocks went nearly vertical," Lee said.

His outlook is counter to that of many other Wall Street strategists. Bank of America, Deutsche Bank, and Morgan Stanley have predicted a 20%-25% decline in the S&P 500 in the first half of the year. A veteran investment chief from Gateway Capital told Insider this week that stocks could crash in 2023, as structural changes in the economy mean the "bull market cocktail" is over.