Fundstrat's Tom Lee pinpoints the single most important indicator signaling strong economic growth — and details his stock-market strategy for taking advantage

  • The January jobs report missed estimates on Friday, but its significance is limited and won’t ultimately hinder the stock market’s upward path, according to Fundstrat’s Tom Lee.
  • Instead, Lee says investors should turn their focus to the steepening yield curve, which suggests that strong economic growth — and subsequent stock strength — is imminent.
  • Detailed below is how investors can take advantage of a strengthening economy and steepening yield curve, according to Fundstrat.
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The economic recovery from the COVID-19 pandemic remains on shaky ground, as evidenced by Friday’s weaker-than-expected January jobs report.

The US added just 49,000 jobs in January, well below the estimate for 105,000 new jobs. But despite the miss, investors shouldn’t be too concerned about the ongoing economic recovery, Fundstrat’s Tom Lee said in a note on Friday.

“The economic recovery will not be ‘linear’ and thus, the month to month change in payrolls will not necessarily be a great snapshot of trend,” Lee explained.

Instead, investors looking for an economic inflection point should turn their focus to a more significant indicator: the yield curve. 

The yield curve charts the difference between long and short-term interest rates. Typically, the curve charts the difference between the 10- and 2-year US Treasury notes, or the 30- and 10-year. Both curves have been steepening since their respective bottoms in 2019 and 2018.

A steepening yield curve typically indicates a strengthening economy, a rise in inflation expectations, and subsequently higher interest rates.

“In our view, this is a sign of strengthening economic growth ahead,” Lee said.

And there are plenty drivers responsible for the possible surge in economic growth going forward, Lee highlighted, including pent-up demand, the “substantial reset” in corporate cost structure thanks to improved operating leverage, and significant fiscal and monetary relief from Congress and the Federal Reserve.

To take advantage of the environment, investors should tilt their portfolios towards “epicenter” stocks, or companies that were most damaged by the COVID-19 pandemic. Lee specifically recommended stocks within the consumer discretionary, financials, industrials, energy, basic materials, and real estate sectors, according to the note. 

“We would see EPS beats as a primary reason to be overweight the Epicenter stocks,” Lee concluded. 

Read more: Bank of America says buy these 17 under-owned stocks that are set to benefit from a faster economic recovery and improved COVID response

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