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Below is an 8 year chart of the SP500 showing the two previous 4 year cycle lows in 1998 and in 2002 as they relate to the RYDEX asset ratio, along with the assumption that the SP500 is near the top of a slightly rising channel; the distance from top to bottom is roughly 400 SP points. In 1998 the 4 year cycle bottom was marked by a 300 point decline in the SP, and the asset ratio around 2.5. In 2002 the 4 year cycle low was marked with a 400 point decline in the SP and the asset ratio again around 2.5. Currently the ratio is at the same levels that in the past 3 years have marked the bottom of minor market declines, followed by rallies to marginal new highs and thus, one can not rule out that perhaps we will see one more marginal recovery high before the wheels for the 4 year cycle low are set in motion. If our assumption about the existence of the channel is correct, then there is a valid possibility--but of course not the certainty--of a 400 point decline between now and October. If the SP doesn't rally over the next few weeks back up towards the 1300 level, then the level to watch for is 1200. If the SP can't hold support above 1200, the next stop will be 1100, which we consider to be "the line in the sand." The only real support below 1100 is between 900 and 800. From a trader's point of view, if there is a 400 point decline in the SP going into the four year cycle low, then one wouldn't want to miss such a move. We do not know what may cause the SP to decline 400 points, but we can not think of anything that may cause the SP to rally 400 points between now and October. Therefore, this is what we have been doing in our own accounts and in qualified managed accounts. We have been selling short the SP Dec06 1475 calls (SXZLO) and we have been using the proceeds to buy the SP Dec06 975 puts (SXBXO) for a net credit.
QQQQ AND THE 4 YEAR CYCLE The chart below is the weekly chart for the QQQQ showing the previous four year cycle low, the mid-point of the current cycle, and the two 2 year cycles that make up the four year cycle, along with the channel that has contained the price action over the last 4 years and the fib retracement levels for the entire advance from the 2002 lows to the 2006 highs. The QQQQ advanced from point A to point B in roughly 15 months, and then it spent the next 8 months declining from the 2 year cycle top at point "B" to its 2 year cycle low at point "A1," which also marked the starting point for the current 2 year cycle. The QQQQ followed the same pattern in the current 2 year cycle as it did in the previous one. It spent 16 months rallying from the bottom at point "A1" to the top at point "B1." Subsequently, it has spent the last 5 months declining as it is headed into the next 2 year cycle low which coincides with the 4 year cycle low. Notice that in the previous 2 year cycle it did not decline straight down from point '"B" to point "A1." Instead it made two interim lows--one of them marked as point "c" before the final low at point "A1." At the moment--in terms of time--the QQQQ is at "C1," which is identical to point "C" in the previous cycle. Hence, if it continues to follow the same pattern and the current cycle plays out as the previous one, then sometime within the next 2 weeks we should have a rally lasting about 5-7 weeks, taking the QQQQ back to 40-41; from there it should turn down and head lower for another 6-8 weeks going into the 4 year cycle low somewhere in the 34-32 zone, and perhaps 28. With regards to trading, in the next 2 weeks we will know if the QQQQ is still following the same pattern. If that turns out to be the case, we would expect it to top out sometime in late July. At that point we will begin to build a sizable short position in our managed accounts.
Ike Iossif
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