The TSP was closed yesterday after some mixed results on Friday, where the I-fund was down and the U.S. stock funds were up.

I have to admit that the S&P 500 charts look quite good, and surprisingly, the indices are not overbought.  We have seen an explosive rally since September 1 but I am skeptical of the probable reasons for this rally.

I believe the upcoming elections have had a major impact on the market this fall.  I also believe that Wall Street is basically pricing in the Fed implementing QE2, or quantitative easing.  Neither will fix the economic problems that many see right around the corner, but they may be acting like a cork in a leaking dike.  It may be holding back the water now, but eventually it is going to come through.  I will be anticipating a "sell the news" reaction if/when QE2 is implemented.  If we don't get QE2 for some reason, then there may be a lot of profits to be taken.

I noticed that the MACD Histogram (moving average convergence/divergence) is showing another obvious divergence.  The MACD is moving downward, and has since it peaked in early September.  When the S&P 500 moves up while the MACD moves downward, you have a divergence and many times this precedes a decline.  These strong trending rallies can last much longer than you would think reasonable, but when they stop, they tend to fall quickly.


                         Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

The VIX (volatility index) pushed below 20 for the first time since the end of April.  The fact that the VIX is moving down is not a problem.  It normally does during rallies, but when we start seeing extreme readings, like the break below the lower Bollinger Band, it could a sign that the market is ready to take a break. 
 
                         Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

But again, the chart looks good, the trend is up, and except for a couple of indicators showing signs that the market needs a break, the market will probably need a catalyst to stop the momentum.  And what could that catalyst be?  Well, we talked about QE 2, but the other catalyst could be the 3rd quarter earnings season.

This chart from SentimenTrader.com shows the past two earnings seasons.  You can see that the S&P 500 was rallying into the earnings season, but quickly peaked and rolled over within a week or so...
     
      
                                 Chart provided courtesy of www.sentimentrader.com

The show us that when the S&P 500 is entering earnings season while hitting a 3-month high, the return is positive on 35% by the end of earnings season (about 27-days).

                             
                                 Chart provided courtesy of www.sentimentrader.com

I wish I could say that I have been taking advantage of this rally, but I can not.  That doesn't mean I won't buy in at some point for a short-term trade, but as soon as the market shows any signs of getting tired, we have enough evidence telling us that a decent correction may be lurking.

Thanks for reading!  We'll see you back here tomorrow.

Tom Crowley