When it comes to whether U. S. stocks are likely to plummet in the near future, many people's first reaction is to check stock valuations or indicators of investor sentiment. Of course, this approach is very easy to understand, because both valuations and market sentiment are indeed quite effective in predicting the future, and it is well known that valuations of US stocks remain high and investors are highly optimistic. It's been quite a while.

Sven Henrich, however, took a different approach and chose to cut in from a third angle-volatility.

Henrich, a highly respected technical analyst and founder of NorthmanTrader.com, explained in a research note released last week that he expected the U.S. stock market to see a sharp rise in volatility in the coming months for a number of reasons.

Henrich found that the Chicago Board options Exchange volatility Index (VIX) has entered a pattern of big gains. The VIX, also known as a "fear indicator", tends to move in the opposite direction to the S & P 500. One of the most typical examples comes from February 2020, when the "fear indicator" soared on the eve of the outbreak and the blockade that led to a sell-off storm in the stock market.

Henrich found that the historical performance of the volatility index over the past four years can be divided into several wedge-shaped trend ranges, and volatility will soar whenever the range narrows, a model that has been fully demonstrated by the history of recent years.

Henrich pointed out in the research report that the performance of volatility indicators in various parts of other markets also showed a similar trend. These parts include small stocks and technology stocks. The details of the two are shown in the following two charts, with the top half of the chart showing the price trend and the lower half showing the volatility trend.

Small stocks:

Technology stocks:

Henrich gave an accurate warning on the eve of last year's US stock market crash, and this time he judged that the surge in volatility covering the entire US stock market would come within this year or early next year, but he also admitted that it is very difficult to determine the exact timing, and the development of the situation depends on a key catalyst.

"it may take months for the whole situation to unfold, but the message from all these models is exactly the same: a surge in volatility is just around the corner. and in a market that continues to behave as if there is only one way forward, every low point will be desperately seized by investors as a buying opportunity, which can only further disconnect the market from the historical trend. "

"if there's anything we learned last year, it's this: extremes can be more extreme. When the situation has reached where it is today, the reaction to the decline is likely to be more severe than anyone could have imagined. "No one can tell us exactly when the top will come," he continued. "but the macro picture of the whole market is becoming increasingly frothy, and the foundation beneath the surface is getting weaker and weaker. "

In terms of weakness, Henrich points out that the simplest fact is that while the S & P 500 is hitting new highs, its market width and relative strength are actually deteriorating.

Henrich did not make it particularly clear that, in his view, it would be appropriate for u.s. stocks to fall, but he did compare the current situation with that of 1998, when u.s. stocks fell 20% during the sell-off. Henrich said that while the 20 per cent decline meets the definition of a so-called "bear market", in fact, it is "healthy" for the market, and at that time, buying opportunities will arise.

With the major indices continuing to rise, a variety of indicators have reached the level only seen in history, but Henrich took a different approach and came to the credible conclusion that the stock market needs a reset from a purely technical point of view.

In fact, there are some observers on Wall Street who believe that it is entirely possible that the 20% decline will become a reality. While some strategists believe that U.S. stocks have room for further gains, two heavyweights in the industry, Bank of America's Savita Subramanian and Stepford's Barry Bannister, both set a year-end target of 3800 for the S & P 500, compared with the current actual level of about 4350, meaning a consolidation of more than 12% by the end of the year.

David Kostin, chief u. S.equity strategist at Goldman Sachs, also pointed out in a recent research report that if the yield on the benchmark 10-year bond soars to 2.5% from the current 1.3%, u.s. stocks are expected to fall 18%.

Inflation has exceeded expectations for three months in a row and continues to rise, surprising everyone, in which case bond investors can actually start demanding higher yields. Higher bond yields mean that bonds become more attractive relative to stocks, eventually causing investors to abandon risky stocks and turn to these risk-free assets.

Other threats to the U. S. stock market are not to be underestimated. For example, novel coronavirus's Delta variant is spreading rapidly in the United States, which may force the government to take further blockade measures. Also, if the economy does show overheating, the Fed may also decide to start scaling back its bond purchases earlier than expected, reducing the liquidity that continues to flow into the economy and the financial system.

In any case, at least the market so far this year still makes the bear pie look stupid. The bulls backed by the Fed are also likely to continue to be happy for some time to come. However, with the increasingly extreme situation of various indicators, investors have no reason to be surprised when the market does fall sharply at some point in the future.