Fundstrat’s Tom Lee thinks the S&P 500 will hit all-time highs by year-end.

Massive stimulus and a sharp rebound in corporate earnings are driving stock prices higher.

There is no better alternative to stocks, as bonds have meager yields.

While many investors believe the stock market will crash soon, Fundstrat’s analyst Tom Lee is optimistic about the market outlook.

Lee believes the stock market will reach record highs by year’s end despite a massive hit to corporate earnings in the second quarter as companies grapple with the coronavirus pandemic.

He sees the S&P 500 trading at 3,450 by the end of 2020 for an implied gain of more than 15% from current levels.

The Stock Market Is Forward-Looking

Lee believes that stocks can still rise while earning go down:

The middle months of 2020 are going to be bad and 2Q 2020 should be a loss … but this does not mean stocks should go down.

Lee has cut his earnings forecast for 2020. He now expects S&P 500 earnings per share to be only $50 for the year, down from his previous estimate of $110.

But he then expects a sharp rebound in corporate earnings, with S&P 500 EPS reaching a record high of $193 in 2021.

Stocks rallying on negative earnings might seem illogical. But the S&P 500 is not the economy. The sharp rebound in earnings could drive equity values higher, as the stock market is forward-looking.

So while things will be bad in 2020, the stock market will continue to rise as a strong recovery is expected in 2021. Investors look past falling earnings, as they think things will be better in three to six months.

Randy Frederick, Charles Schwab’s vice president of trading and derivatives, said:

What the markets are telling us is that, ‘yes, maybe the worst of the economic data has not yet come,’ but the markets are looking several months down the road and saying, ‘are things going to be better? Yes they are.

Fed’s Unprecedented Stimulus Is Driving Stock Prices Higher

The main driver of the stock market’s rebound in recent weeks is likely the Federal Reserve’s actions.

The Fed has taken extraordinary steps to inject trillions into the economy and support the markets.

Isaac Boltansky, director of strategic research at Compass Point Research & Trading, said:

The fundamentals don’t matter as much with this kind of deluge of cash.

Stocks may seem expensive compared to historic earnings valuation measures, but there are no better alternatives. Government bonds offer ultra-low yields, as the Fed has cut interest rates to near zero.

As New York Times columnist Paul Krugman recently noted:

The interest rate on 10-year U.S. government bonds is only 0.6 percent, down from more than 3 percent in late 2018. If you want bonds that are protected against future inflation, their yield is minus half a percent. So buying stock in companies that are still profitable despite the Covid-19 recession looks pretty attractive.

Many companies are doing well, especially in the technology sector. Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOGL), and Facebook (NASDAQ:FB) reported solid profits and account for about a fifth of the S&P 500’s market value.

Tom Lee also thinks that record cash on sidelines ($4.8 trillion, or 16% of market cap) and a potentially accelerated coronavirus vaccine are two reasons the S&P 500 is a pretty good risk-reward right now.

Moderna (NASDAQ:MRNA) said Monday that an early stage vaccine trial had shown positive results.

The stock market rallying on bad economic news doesn’t seem that crazy after all.

Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com and should not be considered investment or trading advice from CCN.com. The writer owns shares of Microsoft (MSFT).