Let's look at the S&P 500, the volatility index, and what will be the trigger or event that sends stock markets around the world to new multi-year lows.
Although the charts shown here are simple, there is a lot of behind-the-scenes information that back up the analysis and predictions included.
For example, the sentiment of the average market participant remains extremely bullish. The majority of investors think that stocks will continue to rise in the coming year.
Typically, when the majority of investors think the same thing it tends to be a contrarian signal that the opposite will soon take place.
Cycle analysis is telling us that the seven-year cycle, which is one of the most powerful cycles that recurs in the stock market is topping. That means we should expect a one-to-three-year stock market correction.
The market breadth has been slowly deteriorating over the past year. Fewer stocks are making new highs, and many leading sectors are already in bear markets.
So it is just a matter of time before U.S. large-capitalization stocks roll over, break down and start a new bear market?
As of Friday, the stock market momentum has shown signs of a short squeeze and the majority of market participants have been in a panic running to buy stocks.
In fact, the New York Stock Exchange's volume ratio shows that there were 18 shares being purchased to every one sold on Friday. A ratio above three is an extreme level, meaning that 18 is signaling a potential significant turning point in stocks in the coming week.
Taking a look at the chart below shows we think the stock market is trading in terms of its 2007 to 2008 market top. The volatility index is also showing similar patterns to what we seen before the 2008 bear market.
Based on the price action of the S&P 500 and the volatility index, it appears that a sharp decline in shares is likely to unfold in the coming weeks.
Take a look at the chart below. The red line is the price of U.S. bonds, and the black candlestick chart is the SPDR S&P 500 Exchange Traded Fund Trust, which tracks the S&P 500.
As shown, the price of bonds start to rally way before the U.S. stock market rolls over and sells off.
Why does this happen?
It looks like the smart money is rotating money slowly out of equities and into bonds in anticipation of a bear market collapse. Bonds act as a safe haven during times of weakness in both the economy and the stock market.
U.S. equities still have a long way to fall before they are technically in a confirmed bear market. The recent rally in bonds is just the beginning of what will happen.
In a recent article, "Deutsche Bank to Initiate the Next Financial Crisis," I wrote about how Deutsche Bank is going down the exact same road as Lehman Brothers Holdings. Both stocks are declining in a similar fashion in terms of share price.
But here is the kicker: Those who thought Lehman Brothers was bad haven't seen anything yet.
The big difference this time around with the banking crisis is that this is 40 times larger than Lehman Brothers and will directly affect almost all key countries and banks around the world. Countries are in far worse shape financially than they were in 2008 during Lehman Brothers bankruptcy.
In short, the U.S. stock market is trying to hold up and convince investors that everything is fine. Although stocks are testing all-time highs, the market is much weaker than it appears.
A lot of things are coming together to form a major market top, but like all previous stock market tops, they require time to mature before they break down and new nominal highs are sen.