The economy is expanding and investors need to buy the dip in stocks, Fundstrat says

"In the meantime, we believe markets have entered a 'buy the dip' regime where 2% pullbacks need to be bought."

• Investors should buy the recent pullback in equities, Fundstrat's Tom Lee said.
• He called the sell-off in response to the hot ADP jobs report "exaggerated."
• But the economy is actually "slipping into an expansion," Lee said, setting up stocks for gains.

The buy-the-dip regime in stocks is back – and investors should take advantage of the recent pullback in equities as the economy is expanding, according to Fundstrat's head of research Tom Lee. 

Lee, who has been bullish on stocks for most of the past year's bear market, pointed to the sharp fall in equities Thursday after ADP's payroll report, which showed the private sector added 497,000 jobs last month, about double what economists expected.

That sparked a steep sell-off, with the Dow shedding over 300 points on Thursday as investors priced in more interest rate hikes from the Fed.

But fears of more Fed tightening are largely misplaced, Lee said, as the more important inflation indicator in the labor market is wage growth, rather than the number of jobs added. That's because higher wages can influence firms to raise prices, setting off a wage-price spiral that can worsen inflation. 

The percentage of small businesses that have raised wages just fell to a two-year-low, according to the latest small business report. That could spell good news for the outlook on inflation as well as stocks.

But Lee's comments came before the Labor Department released its June jobs report early Friday. It showed that while hiring slowed down, wage growth came in hotter than expected, sending stocks lower. 

Meanwhile, he also pointed to the recent correlation between higher Treasury yields and corporate earnings. That's a sign that the economy is actually "slipping into an expansion," not a recession, he said, which strengthens the bull case for equities. 

"We view today's sell-off as largely noise," Lee said in a note on Thursday. "The 'hot' employment figure is wages, more so than actual jobs added. In the meantime, we believe markets have entered a 'buy the dip' regime where 2% pullbacks need to be bought," he later added. 

A cooler labor market spells good news for stocks, as tight employment conditions can worsen inflation. Central bankers, meanwhile, have raised interest rates aggressively over the past year to tame high prices, which weighed the S&P 500 down 20% in 2022.

In a previous note, Lee predicted the benchmark index would notch a new record of 4,825 by the end of 2023, representing 16% upside for the year.

His view, however, is contrary to other Wall Street strategists, who have been sounding the alarm for a coming recession and headwinds for stocks over the past year. The economy has a 71% chance of slipping into a recession by May 2024, according to the latest projection from the New York Fed.