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- The stock market is on the verge of ending its year-long bear market and entering a new bull market.
- One signal that would suggest the bear market is over is a continued decline in equity volatility.
- Here's exactly what needs to happen for the stock market to enter a new sustainable bull market, according to Fairlead Strategies.
The stock market is sitting on the edge of ending a year-long bear market and entering a new bull market after the S&P 500 staged an impressive 18% rally from its mid-October low.
But in order for a new bull market to be sustainable, a few signals have to flash, according to a Wednesday note from Fairlead Strategies' Katie Stockton.
Stockton said the current short- and long-term bias of the stock market leans bearish, but that progress has been made amid an ongoing consolidation phase that has absorbed short-term overbought conditions. And the short-term volatility is likely not over.
"Short-term momentum is likely to wane for the market as a whole, noting the mega cap stocks are now showing daily MACD 'sell' signals, so we would keep a bearish bias," she said, referring to the moving average convergence/divergence indicator.
A decline could send the S&P 500 to Stockton's support level of about 3,800, which would represent potential downside of 8% from current levels.
But if stocks can manage to continue their consolidation phase and edge less than 1% higher from current levels, a new bull market could be upon us, according to Stockton, who highlighted 4,155 on the S&P 500 as a key resistance level that needs to be cleared.
"Should the S&P 500 post consecutive weekly closes above 4,155, its downtrend would be reversed, dictating a bullish intermediate-term bias," she explained.
And if a potential breakout above that key resistance level coincides with a continued decline in stock market volatility, as measured by the CBOE Volatility Index (VIX), then the rally could really get going, according to the note.
"Should the VIX break support at 18.45 decisively, that would be another bullish indication, reflecting a major shift in market sentiment," it said.
With the VIX currently trading at 18.34 and the S&P 500 trading at 4,125, the market is not far off from triggering the two big criteria Stockton wants to see to suggest that the market trend has flipped from a bear to a bull.
"If these levels are broken decisively, it would signal a bullish reversal," Stockton said.
And that could be bad news for the hedge funds that have built up one of the biggest shorts against the stock market since 2011, which according to some analysts could trigger a short squeeze.