In a bold forecast that has Wall Street buzzing, Tom Lee, the head of research at Fundstrat Global Advisors and chief investment officer at Fundstrat Capital, predicted on Monday that the S&P 500 index will climb to 7,700 by the end of 2026, even as the market endures a rollercoaster year of highs and lows. Speaking on CNBC's "Squawk Box," Lee described 2026 as a period of "joy, depression, and rally," echoing the volatile pattern observed in 2025. He anticipates a significant 15-20% correction in the latter half of the year, driven largely by the Federal Reserve's interest rate policies, but remains optimistic about an eventual rebound fueled by several economic tailwinds.
Lee's appearance on the morning program came amid ongoing discussions about the trajectory of U.S. equities following a strong performance in recent months. Over the past year, the Invesco QQQ Trust, Series 1 (NASDAQ:QQQ), which tracks the Nasdaq-100, has risen 16.89%, while the Vanguard S&P 500 ETF (NYSEARCA:VOO) has gained 14.74%, according to data from Benzinga Pro. These gains reflect broader market resilience, but Lee warned that investors should brace for turbulence ahead, particularly as the Fed navigates its rate-cutting cycle.
According to Lee, the potential for volatility stems from the interplay between monetary policy and global trade dynamics. He pointed to the upcoming anniversary of tariffs imposed during the previous administration as a factor that could influence market sentiment, alongside anticipated Federal Reserve rate cuts and a possible rebound in the Institute for Supply Management (ISM) index, a key gauge of manufacturing activity. "The market's performance in 2026 would be marked by 'joy, depression, and rally,' similar to the pattern seen in 2025," Lee said, emphasizing that these swings would test investor resolve but ultimately lead to higher levels.
Highlighting sectors poised for growth, Lee singled out energy, financials, and small-cap stocks as areas that have lagged behind in recent years but could drive the next leg of market expansion. He noted that small caps, represented by indices like the Russell 2000, reached an all-time high in 2025, a milestone he attributes to improving fundamentals. Lower interest rates, in particular, are expected to ease borrowing costs for smaller companies, which often rely more heavily on debt financing than their larger counterparts.
"Monetary easing, earnings growth is starting to look better, and if we have mergers, I think all of these are tailwinds for small caps," Lee stated during the interview.
Lee's endorsement of small caps aligns with views from other market analysts who see a shift in leadership away from the mega-cap tech stocks that dominated 2024 and 2025. For instance, Louis Navellier, a veteran investor and chief investment officer at Navellier & Associates, recently advised investors to prioritize stocks with robust earnings growth as the market potentially undergoes a "big flip" in January. Navellier suggested this rotation could propel the S&P 500 higher, supporting Lee's overall bullish outlook for the index.
Bank of America analysts have echoed this sentiment in a recent report, forecasting that small-cap stocks will outperform both mid-cap and large-cap peers in 2026. The firm outlined five key reasons for this potential surge: improving earnings momentum among smaller companies, a capital expenditure (capex) cycle that boosts revenues, Federal Reserve rate cuts that alleviate financing pressures, reduced tariffs and deregulation enhancing profit margins, and attractive valuations bolstered by favorable investor positioning. According to the report, these factors could create a fertile environment for small caps to catch up after years of underperformance relative to the broader market.
While Lee's prediction places the S&P 500 at 7,700—a level that would represent roughly a 40% increase from current levels around 5,500—the path to that target is expected to be bumpy. The 15-20% correction he foresees in the second half of 2026 could erase much of the year's early gains, reminiscent of mid-year dips seen in previous cycles. Historical context underscores the realism of such volatility; for example, the S&P 500 experienced a 19.4% drawdown in 2022 amid rising rates, only to rebound sharply in 2023 as inflation cooled.
Fundstrat's analysis draws on a combination of macroeconomic indicators and sector-specific trends. The ISM index, which Lee mentioned as a potential rebound catalyst, has hovered around contractionary levels in recent months, with the manufacturing component dipping below 50—a threshold signaling economic slowdown. A reversal here could signal broader industrial recovery, benefiting cyclical sectors like energy and financials that Lee favors.
On the tariff front, Lee referenced the one-year mark since certain trade policies took effect, suggesting that any resolutions or adjustments could alleviate pressures on global supply chains. This comes as U.S.-China trade tensions remain a backdrop to market movements, with investors watching for signals from the incoming administration on policy continuity or change. Lower tariffs, as noted by Bank of America, could particularly aid small caps by reducing input costs and improving competitiveness.
Small-cap enthusiasm is not without caveats. Critics in the financial community point out that smaller companies often face higher risks during economic uncertainty, including greater sensitivity to interest rate changes and weaker balance sheets. However, proponents like Lee argue that the current setup—declining rates and improving earnings—mitigates these vulnerabilities. Navellier's focus on earnings growth further reinforces this view, as he urges a selective approach to avoid value traps in the small-cap space.
The broader implications of Lee's forecast extend beyond individual sectors to the overall health of the U.S. economy. A rally in small caps could signal a more balanced recovery, distributing gains away from the handful of technology giants that have driven much of the market's appreciation. This rotation might also encourage merger and acquisition activity, as lower rates make deals more feasible and attractive, providing another tailwind as Lee described.
Looking ahead, investors are likely to monitor upcoming Federal Reserve meetings closely, with the next policy decision scheduled for late January. Fed Chair Jerome Powell has indicated a data-dependent approach to further cuts, which could either validate or challenge Lee's optimistic scenario. Meanwhile, quarterly earnings reports from small-cap heavyweights will offer early clues about the earnings momentum Bank of America anticipates.
In the context of global markets, Lee's U.S.-centric predictions come as European and Asian indices grapple with their own challenges, including geopolitical risks and slowing growth. A strong S&P 500 performance could provide a lift to international sentiment, but divergences in policy—such as the European Central Bank's more cautious stance on rates—might limit spillover effects.
As 2026 approaches, Lee's forecast serves as a reminder of the market's inherent unpredictability. While his track record includes accurate calls on past bull runs, such as the post-2022 recovery, the blend of joy and depression he envisions underscores the need for diversified strategies. For now, the focus remains on small caps as potential winners, with analysts across the board agreeing that lower rates and policy shifts could unlock significant upside.
With the S&P 500's current momentum and historical precedents in mind, the coming year promises to be one of heightened drama on Wall Street. Whether it culminates in the 7,700 target or falls short, Lee's insights highlight the sectors and dynamics worth watching as investors navigate the road ahead.