A historic decline in volatility sets the stock market up for more gains ahead, Fundstrat's Tom Lee says

• A near 40% decline in volatility this week suggests the stock market has more room to the upside, according to Fundstrat.
• The volatility decline was likely sparked by extreme de-leveraging due to the GameStop short-squeeze.
• The stock market has historically been higher 87% of the time in the months after such a steep decline in the Cboe Volatility Index, or VIX.
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The stock market's fear gauge - or the Cboe Volatility index, also known as the VIX - has staged a historic decline over the past three days, falling a record 39%.

According to Fundstrat's Tom Lee, that's a signal that the stock market has more room to the upside over the next few months, according to a Wednesday note.

The volatility decline was likely sparked by hedge funds de-leveraging their portfolios following the epic short-squeeze rally in shares of GameStop last week.

The de-leveraging, combined with the the decline in the VIX this week, has Lee pondering if the recent 3% selloff in the S&P 500 is over. Lee had been forecasting a 10% sell-off to hit stocks in the early part of 2021.

Analyzing the 40 largest three-day drops in the VIX, stocks were higher 87% of the time over the next six months, and 65% of the time over the next three months, according to Lee. The average six month return following the volatility declines was 5%.

There have been some head fakes though, with a steep three-day decline in volatility also occurring in October and November of 2008.

"So, if you believe this is 2008, then stocks are in trouble. But if you believe this is anything BUT 2008, the correction is DONE," Lee said.

And a recent 8% rally in energy stocks over the past week supports the idea that the recent stock market correction is over, Lee said, citing a "risk-on" environment.

"So, is the stock market finally beginning to price in 'end of COVID?" Lee pondered.

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