The upcoming earnings season will be a make or break moment for stocks and could finally cause the bears to throw in the towel, Fundstrat says

• Stocks are about to enter a pivotal earnings season, according to Fundstrat's Tom Lee.
• A strong showing could be the catalyst for the bears to capitulate, Lee said.

The upcoming earnings season will be a make or break moment for stocks, and it could finally be the moment that causes bears to capitulate, according to Fundstrat's head of research Tom Lee.

In a note on Wednesday, Lee pointed to the case made by bearish investors, who say the Fed's aggressive rate hikes over the past year have broken something the economy. That sentiment was on display last month amid the collapse of Silicon Valley Bank, which some believe raised the odds of recession and will spell trouble for the market through the rest of this year.

But in reality, it's inflation that's breaking, Lee said, a fact that could become clearer in the case of strong corporate earnings for the first quarter.

"It may be that 1Q2023 earnings season could act as the final 'capitulation' of the bearish view," he added, predicting stocks could see the strongest rally of the year in April. Previously, he's predicted the S&P 500 will gain at least 20% this year, retesting its all-time high of 4,800.

His bearish view runs counter to many others on Wall Street, with earnings expectations falling for the past six months and analysts warning that high inflation could drag corporate earnings. But expectations have started to bottom out in seven out of 11 major sectors in the market, Lee said, and at the same time, inflation metrics have started to ease.

The core Personal Consumption Expenditures index – the Fed's preferred inflation gauge, which excludes more volatile food and energy prices – rose just 0.3% in February, cooler than the expected 0.4% increase. Meanwhile, supercore PCE, which also excludes housing prices, fell to 3.3% in March, the measure's lowest level since July 2022.

The labor market is also starting to soften. Job openings fell to 9.9 million in February, lower than the expected 10.5 million, Lee pointed, another sign that the economy is starting to shrink from Fed policy. Wednesday private payroll data for March showed hiring slowed last month, the latest sign that the job market is decelerating after a year of policy tightening by the Federal Reserve.

Fed officials have hiked interest rates over 1,700% in the past year to lower high prices, but dwindling inflation indicators suggest the central bank is running out of reasons to keep tightening the screws on the economy, Lee said.