Year Of The Rat

According to the Chinese Zodiac, 2008 is the Year of the Rat (Earth), which began on February 7, 2008 and ends on January 25, 2009.  First in the cycle of 12 Animal signs, Rat Year begins the sequence and recurs every twelfth year. It is a time of renewal in so many ways.

Yeah – no kidding!

Let me add to that – when reflecting back on the past ten months it has become abundantly clear that 2008 has been the year of a particular breed of rat – the stainless steel rat. What sort of rat is that? It’s a rare type of creature which seeks out and ruthlessly exploits opportunities when others only see chaos and adversity. Unlike its more commonly known rodent cousin it does not live in packs but often collaborates to assure its survival or to gain an advantage. Shunned and execrated by society at large the stainless steel rat operates out of sight, behind the walls of the system, unseen, silent, and mostly ignored.

Restless and inquisitive, we are are active, both physically and mentally, tending to lead busy lives. Challenge is essential to us for we love the thrill of living dangerously. With clairvoyance, intuition and an eye for detail, we are formidable problem solvers, finding workable solutions to the knottiest problems.

As this year slowly draws to a close I must say that I am proud of what we rats have accomplished so far. After all, we have flourished where others have failed miserably. Is it because we are so much smarter than the average trader out there? I would love to say yes, but that would probably be a bit complacent – it’s quite natural to overestimate one’s own intelligence, but chances are most of us are of the average variety. What however separates us foremost of all is a heightened sense of distrust and suspicion regarding any information we receive from the propaganda machines that command the masses of lemmings commonly referred to as the ‘average investor.’

The bubble heads on financial news networks have been assuring us for over a year now that ‘everything will be fine’, and that there is little chance of a recession, contrary to all the facts of course. Then, when it was clear that this all was a stinking heap of lies (big surprise) we were told that any recession will be ‘shallow’ and will last a few months at most. Now the roaring debate is over whether or not this ‘was the bottom’ and exactly when those rosy times are ahead again.

Of course, what did we do all along? The opposite of what we were told to do – stainless steel rat style – and thus shortened the heck out of the market at every turn. Has it been easy? Of course not – the powers that be run the show and we are merely lowly rats that feed off the crumbs that fall between the cracks when the tectonic continental shelves of finance begin to shift into reverse. But despite numerous surprise interventions by those high priests of finance, and several setbacks caused by a sudden change of the rules, we are still alive and kicking. For we are extremely difficult to eradicate – we can smell disaster miles ahead due to a highly developed sense self preservation mixed with paranoia. Thus we have no compunction about jumping ship at the slightest sense of trouble and we are proud of that fact. After all we are no heroes – for those die in battles at the command of generals who only have their own selfish interest in mind. Stainless steel rats know that true advantage and fortune stems from preservation and being able to fight another day. We also understand that at the end of the day, we are alone in our quest and that we cannot and must not put our prosperity and future into the hands of others.

Unlike the pirates and gnomes running our financial system who happily enrich themselves at the disfortune of the working class, we rats mainly benefit when greed and hubris are in oversupply. Those are the times when our ranks swell and we flourish in numbers. We don’t really recruit as those who accept our truths and perception of reality usually find us. You can’t become a stainless steel rat – you are either one at young age or you will never understand our way. Like our distant cousins, the vulture, we also know when to sit and wait – and we only strike when the advantage has shifted clearly in our favor. How do we know when that moment has arrived? For we are insatiable when it comes to the evaluation of probabilities in market trends. We use only select tools that are proven to reliably measure the tides of the market – and unless we feel the wind in our backs we do not make a move. Finally, we do not take sides – and we are happy to ride on the tails of bears and bulls alike.

With all that in mind I would like to talk about what the coming week might have in store for us rats. There are arguments that lead us to both the bearish and bullish side of things and the emphasis for us will be on not making a decisive move until we find the odds strongly in our favor. Trading ahead of a clear resolution is simply motivated by greed and wishful thinking, and runs contrary to our stainless steel rat creed. The wave count remains to be inconclusive, but despite all criticism I have received in the past week, it does start to resemble the triangle pattern I suggested in mid October. Although the chart looks messy, it’s not that hard to understand and I have tried my best to point out the three scenarios I give the highest probabilities as of now. As part of the triangle Scenario A points down after a little pop to the upside. Scenario B indicates that {d} of 4 has alread bottomed and that the first turning point should be at the upper triangle border. Both A and B lead us to the downside around 750 on the SPX, our preliminary target. Due to the strength of the preceding downside move and the overwhelming negative breadth on Wednesday and Thursday I give Scenario A the highest probability rating of 40% as of now. It would also give the triangle pattern additional credence. Scenario B receives 30%, as I consider it a possibility but it’s not ideal in terms of the wave count. If we actually wind up tracing this one out over Monday/Tuesday, I would have to add a higher chance to Scenario C.

C is the bullish runner up and would of course require an adjustment of the wave count. Coincidentally this would be minor wave C of intermediate (4) or perhaps even minute wave {iii} of A of (4).

The reason why I am giving this one also a high probability of 30% is due to the continuously narrowing TED spread. Then there’s the narrowing of the spread between the Moody’s BAA bond yield and the 30 year T-Bond yield ($TYX), which has now slimmed to 4.94% (it was 5.3% a few days ago). Again, a slight narrowing does not always assure a bullish counter trend move but if it keeps narrowing we need to seriously consider this is a possibility. What also concerns me is not so much the $TYX, but the Moody’s yield that has started to descent.

The bubble on this chart was supposed to say ‘on the rise but flattening’ – but after three attempts I gave up on jing. The message remains clear here and also continues to support the potential for a bullish rally. Unless I see the weekly stochastic flatten further and perhaps even below the 25% line I remain on code yellow for the bearish case.

You have probably seen this chart floating around in the last few days – I also posted it last week myself. Although the pattern is not super clean we might have ourselves the potential for a massive inverse Head & Shoulder formation here, which if it would play out would present us with a monster rally leading us up to 1120 on the SPX.

Which brings me back to the first chart I posted. Based on various conflicting signals it may be wise to stay out of the market unless we see some much needed clarification. Thus, I have attempted to label that chart with good entry and exit points, as those represent moments in the price pattern that would give us the highest probability for defensible positions. We would also know in a relatively short amount of time if we were wrong and that it is either time to move to the sidelines again, or to reverse our positions. For those of you who were caught on the short side of the stick last Friday I have also marked the point where I would start cutting those positions, as the probabilities for a reversal would be greatly diminished past those thresholds.

For your convenienece here is a slightly magnified chart with the new weekly retracement levels, courtesy of 2sweeties over at retracementlevels.com – a friend of the blog. The prior chart still has the old ones on there as I made it yesterday evening. Incidentally, we were told this morning that 2sweeties also added a daily USD/JPY retracement calculator, which is a wonderful and much needed addition to the current choices. Once I figure out which values to enter, I will report back here. Usually I look at the Yen futures in the ‘raw’ which currently is the @6JZ8 symbol in Prophet charts or the Yen index ($XJY) over at stockcharts.com. So, if 2sweeties could post a tutorial including some symbols/sources of what to look at I’m sure many here would appreciate it.

My apologies for being so obsessed with triangles as of late (earlier this year it was wedges – LOL), but I think that’s what we are tracing out in Gold right now. If that is what’s happening then the wave count above would change a little bit as {iv} would move to the end of wave (d) at the completion of the triangle. In continue to believe that we will see more downside in Gold in the coming weeks, and this remains in effect unless I see 778 being breached.

Zigzag posted about the Rydex Nova/Ursa ratio, which I have never used but appears to be a good indicator for actual bullish/bearish sentiment in the market. Investopedia offers this:

A sentiment indicator based on the Nova and Ursa funds from the Rydex Fund Group. The Nova fund is bullish with a target beta of 1.5. Whereas, the Ursa fund is bearish with a target beta of -1.0. This ratio can be used as a proxy for the direction of market sentiment. More specifically, a high value represents a bullish sentiment and a low value represents a bearish sentiment.

Looking at the current chart above it seems that investor sentiment remains clearly bullish right now – perhaps too bullish for their own good.

The more longer term NYSE Bullish Percent Index seems to support that – we are in bullish territory but not exactly super overbought. But then again – just like 40 is the new 20 in the VIX – perhaps 40 is the new 60 in the $BPNYA.

The more shorter term McClellan Oscillator also remains in bullish territory, however more upside is possible here as well. Perhaps that gives Scenario B more credence?

There you have it my dear stainless steel rodent leeches – this should give you all something to chew on for the evening. Let’s keep it clean and in the spirit of the approach that has worked for us so far. If we have to wait a week to get clarification, then be it! I for one made the mistake to take a few trades on Friday before one of my indicators gave me a clear signal and I dearly paid for it at the close. We all get seduced by the dark side every once in a while, but if we want to survive and continue to swim with the sharks then we need to acknowledge mistakes, swallow our pride, and continue to stick with the system. I for one will remain mostly in cash until I see the stars align clearly for some much needed resolution. It will happen – but no matter how bad we want it we have no impact on which way the market is going to swing. Best we can do is to read our tea leafs and jump into the fray when we see a clear advantage. I don’t see that right now, so let’s not do anything stupid until we do. I hope I have been crystal clear here – remember, no matter how smart you think you are – the market is always smarter.

Cheers!