The S&P 500 bounce is just beginning of a rally, says JPMorgan technical analyst

Jason Hunter, technical analyst at JPMorgan, said that the S&P 500's strong start to October was just the beginning of a rally that should last through the end of the year.

The recent price action and technical setup suggests that the fourth-quarter bounce is under way, Hunter wrote in a note to clients.

The S&P 500 index s SPX, two-day surge of 5.7% through Tuesday, was the best two-day start to a quarter in 84 years and caused a cluster of momentum divergence buy signals. Hunter believes that the rally can continue, given that signals coincide with a deep oversold technical condition and historically bearish sentiment readings.

Hunter believes that the bounce could take the S&P 500 back up to test prior resistance at the 200 day moving average, which many chart watchers view as a dividing line between longer-term uptrends and downtrends. The 200 day extension extends to 4,199 on Wednesday, which is about 12% higher than current levels, according to FactSet.

The S&P 500 slipped 0.2% in the afternoon, but was down 0.8% in the earlier intraday loss of as much as 1.8%.

One reason for Hunter's bullish view is that the S&P 500 s bounce came from deep oversold internal breadth readings, which suggests that the number of declining stocks relative to advancers has stretched to levels that coincided with market bounces in the past.

Gail Dudack, chief investment strategist at Dudack Research Group, said just before the S&P 500's big bounce, the 25 day up-down volume technical indicator was at a level that was associated with an oversold condition for 10 days and was at a more extreme oversold reading than at the June low, which preceded a two-month uptrend that took the S&P 500 up 17%.

The AAII Sentiment Survey of individual investors showed that those who were bearish on stocks reached 60.9% during the week ended Sept. 21, the highest percentage since March 5, 2009, or just before the S&P 500 bottomed after the financial crisis.

The stock market is poised to confirm a weekly momentum diverging buy signal that historically has had a good hit rate for the S&P 500 index, according to JPMorgan s Hunter. A bullish technical divergence refers to when prices keep falling even after some momentum indicators, such as the Relative Strength Index RSI, have started to move higher. The RSI is a widely followed oscillating indicator that tracks the magnitude of losses relative to the magnitude of recent gains. Read more about how to interpret RSI divergence.

The following chart shows what bullish divergence looks like:

After the financial crisis, there was a similar divergence as the S&P 500 bottomed in 2009:

After the Internet bubble popped, there was another divergence as the market bottomed in 2002.

JPMorgan s Hunter said he believes sustained daily closes above resistance at the Sept. 28 intraday high at 3,736. The S&P 500 is poised to close above that for a second consecutive day, and he wants to keep momentum positive, and target the next resistance area at 3,900.

He believes that the 4,100 to 4,200 zone, which the 200 day zone will decline into during the fourth quarter, could act as a meaningful barrier.