The Big Picture

Christmas is only a few days away and many of our steel rats are busy rounding up the rest of their litter for some well deserved holiday jubilation. And rightfully so, as we stainless steel rats are among a small family of rodent species that saw their economic prospects actually increase throughout 2008. If you haven’t at least added 50% to your assets this year then you really need to come by here more often. Knowledge is power – and thus profit – if you know how to leverage what you know of course. Anticipation of the market tanking is one thing – taking full advantage of it, is yet another.

For my weekend update today I have decided to take a step back and focus on the big picture. Because, looking at 2009 I am confident in making the following prediction:

If you think 2008 was bad, just wait for 2009. It’s going to get even uglier.

But…. oh grandmaster rat… we hear the words you speak but our minuscule rat brains don’t grasp their meaning! Have no fear – my trusted leeches – I’m here to help:

What you see before you is an idealized Elliott Wave principle model that spans several decades. The pattern is inherently fractal by design in that it subdivides into smaller units which all exhibit the same pattern of its larger degree parent. This is how we arrive at lower degree wave patterns which then again subdivide into further lower degree wave patterns, and so on. Wave degrees are measured in decades, years, months, weeks, days, and even minutes. Admittedly, Berk and I focus mostly on the monthly and weekly patterns, as those are of most interest to us options traders.

The basic pattern is pretty simple, and even those tiny rat brains rattling around in those thick skulls of yours should be able to grasp the basic principle: 5 motive waves up followed by 3 corrective waves down (i.e. an a/b/c) – that’s it. To put the big picture into some kind of context I have marked the peak of the last secular bull market which occurred in January 2000. From there we actually descended into a large zigzag (i.e. the large a/b/c waves on the right hand of the chart) which is the Elliott Wave Theory (EWT) definition of a bear market. The zigzag itself again sub-divides into 5 motive waves down, followed an a/b/c correction up, followed by a final motive wave down.

Let’s put all that into context – here’s a Dow chart of the past eight years. Obviously, there’s a bit of difference between the idealized map shown above and the actual wave pattern, but I have done my best to label the chart appropriately. As a side note – when put into context it’s very interesting how things have accelerated in the past year. Moves that took years to trace out now transpire in months or weeks.

Now some of your less dim-witted rats might rub your furry paws right now, thinking you have uncovered a major flaw in our theory: So, if that’s true – how come the 2007 peak is actually above the supposed bull market peak in 2000?

Answer: Inflation – which I also often lovingly refer to as the ‘hidden tax on the stupid’. Take a peek at an inflation adjusted Dow chart with some interesting accompanying data. Maybe now things fall into focus for you – what you see charted in Dollar values all over the place should be taken with a healthy amount of skepticism – especially going forward into 2009. Bernanke and friends have printed so much money that you could stack 1-Dollar bills from to the moon and back.

Oh, you think I was kidding? Let’s do a quick math experiment before we move on:

A 1-Dollar bill is .0043 inches thick. 1 million stacked dollar bills is .067 miles, less than a tenth of a mile. 1 trillion dollar bills would be the equivalent of eight and a half planet earths stacked on top of each other.

Let’s do this another way:

One thousand times one million = one billion.
One thousand times one billion = one trillion
In other words. One million times one million = one trillion.

A one trillion dollar stack of 1-Dollar bills would be one million times higher than the million dollar stack -or- picture it this way: It would take one million stacks of one million dollar bills to equal one trillion dollars.

If the million dollar stack is indeed .067 miles high, then the trillion dollar stack would be 67,000 miles high, which is fairly near to one third the distance from the Earth to the moon.

Based on the most recent data out there the PPT has been racking up close to 8 Trillion Dollars in bailouts and other types of crony assistance. That is over half a million miles of 1-Dollar bills stacked on top of each other (not sideways).

So, if you have any illusions about what’s going to happen to the U.S. Dollar in the months years to come, think again.

But, back to our EWT model – here’s a zoomed-in version of the first overview chart and I have marked our current location in the wave pattern. In EWT lingo we are in Minor wave C of Intermediate wave (4) of Primary wave {1} of cycle wave c – and yes, there’s plenty more downside to come. This might shock you, especially if you are a recovering viewer of the Jim Cramer show. Which is kind of the point I’m trying to make here today. If this crushed your last remaining hopes for a speedy recovery as promised by the untiring ‘bottom-is-in’ crowd, then good – maybe I’ve done my job. After all, a main key to banking coin in the markets is to embrace reality – wishful thinking a sure way to go broke on the double.

Now, that you know where we are – let’s put things a bit more into context: We are getting close to completing that little push the upside which is marked by a circle. After that we will breach the November 21 lows and descent into a temporary low. I expect that low to happen sometime between April and June of 2009. After that we will embark on a multi-month sucker rally (an a/b/c up) that might get us back to about where we are now. So, if you check your stock portfolio in December 2009, you’ll realize that we probably didn’t make much progress. However, there’s a caveat – on paper you’ll see similar numbers in the averages, but in terms of buying power it will most likely be less as the Dollar is going to drop significantly throughout 2009.

There will be a point when we will recommend loading up on physical Gold – maybe Uranium for our most evil leeches, assuming you gain access to some retired Russian sub. But for now Gold is going to head south and touch 650 – we’re sticking with that unless we see a push above the low 900s.

So, that’s the rub for 2009. It won’t be fun for investors – but it’ll be great for traders. Plenty of ups and downs to trade, and then – starting in 2010 – we start all over again and repeat the kind of tape we saw in 2008.

One more thought before I move on to my SPX chart and next week’s forecast: Now that you understand where we are and where we are heading in the coming months, you also might grasp why Berk and I are very eager to load up on index puts once we hit the tip of the current rally. This will probably be around the beginning of January – depending on what happens during the remaining trading days of 2008. Some of your regular rats might remember my profit analysis of how much $4000.- worth of ATM Spider puts purchased mid-July would have been worth on November 20th. Answer: only about $70,000.-.

So, I’m not sure what your plans are for 2009, but grabbing a few grant worth of April/May SPY puts in a few weeks from now may not be the worst trade you’ll do next year 😉

Nothing really has changed in terms of the two scenarios I laid out last Sunday. We whipsawed our way up (as expected) and unless we breach that ascending support line I’ve drawn on the updated chart above we should be heading higher and touch the 940 region. The tip of {b} of C is what I was referring to previously. Yes, if we trace out a final motive to the upside (the blue scenario) sometimes in January we might take a small loss, but that’s what I love about this pattern – the upper boundaries are great defensive lines which will allow us to manage our trades. If we push past that at the separation zone around 920 a month from now – well, either hold on to those suckers, or cut them and double down once we reach 1020 – 1040.

I’m not going to delve into many supportive indicators as really not much has changed on the equities side. The Dollar of course has taken a major tumble – this will have a major impact on commodities going forward. $NYMO and $BPNYA still sky high – so, it’s fair to say we are officially in overbought territory. FYI – the spread between the Moody’s BAA corporate yield and the $TYX is still at record highs and growing – while the BAA yield has dropped a little bit the T-Bond yield has completely fallen off the plate. This alone bodes very badly for the bulls on a medium term basis, and the widening yield spread between ‘safe’ treasuries and corporate debt supports our view that the current leg up is nothing but a relief rally after heavily oversold conditions at the end of November.

But I kept the best one for last. This is a chart of the CBOE put/call ratio index and you can clearly see how we are again approaching the 0.825 region which seems to have preceded a major drop in equities in the past month. Will this happen again? Well, I don’t have a crystal ball but considering the currently overbought conditions which obviously have prevailed or several weeks now – I’m keeping my modified high voltage bull-prod ready and charged 🙂

Okay, one more since I’m feeling generous. Take a look at the Gold chart above – if we are so lucky to see 860 or above again this week and you don’t grab puts or short positions here – well, don’t blame me, I’ve done my part 😉

Cheers!

Michael