TSP Talk Blog

10/17/11

Stocks rallied strongly again on Friday, putting an exclamation point on a big week for stocks.

As many investors continue to expect a pullback, the market continues to move up leaving them behind, forcing some to buy or cover short positions, and the market is using that as ammunition to rally. The Dow gained 166-points on Friday.



For the TSP, the C-fund was up 1.74% on Friday, the S-fund gained 1.88%, the I-fund added 1.19%, and the F-fund (bonds) lost 0.18%.

For more on the weekly and monthly returns, please see our TSP Weekly Wrap-Up.

The S&P 500 has come a long way in a short time. On October 4 we wrote about how the activity at the time, which was pretty rare, had led to an average gain of 11.1% over the next week or so. The current 10% plus gain since has not disappointed the bulls. I ended that commentary by saying, "I just have to remember to sell the rallies." I did, but it turned out to be way too early.

The S&P is at a perfect area where we could see a pullback since we are near resistance and the indices are so overbought, but breakouts manifest by making higher highs above old highs - and either can happen here.


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

The PMO indicator is on a buy but you can see that when the PMO itself (blue) is getting this much separation from its 10-day EMA (green) it is an indication that the index is quite overbought. I marked prior instances on the above chart where we saw this kind of separation.

The Nasdaq has made a new high, but I am concerned that volume has been contracting during this rally.


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

We have seen this before in 2008 when the S&P 500 rebounded strongly in July / August of '08 while volume contracted. It led to another leg down.


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

Also shown, when the 20-day EMA is below the 50-day EMA during a bear market, and it makes an attempt to cross above, or actually does move above, the 50-day EMA, it tends to be another sign of a tired, overbought market.

It's not an instant gratification indicator as you can see some of the rallies went on a while before topping and heading down, but it was pretty constant. I lost 35% in 2008 trying to buy the dips and not selling the rallies and that left a mark that won't easily be forgotten.

During the 2010 correction (and because of how tight the 50-day EMA and the 200-day EMA were, it was arguable whether or not we were in a bear market) the 20 EMA crossing above the 50 EMA did cause another temporary top, but by September 1 the market took off and never looked back.


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

This is what the bears are afraid of now. If this bear market is going to end and turn into a bull market, and that will take a while to officially happen, the bears could be left behind waiting for a meaningful pullback to buy, and like 2010, it could be weeks or months.

One of Trader Fred's indicators is a Market Strength Indicator. He doesn't use this specifically to make allocation decisions since that is all done by a series of computer generated submodels, but the chart below, which he posts in all of his reports, has always intrigued me. Sometimes it is scary how accurate it is, and other times it seems to stray. Basically its purpose is to lead the market. That is, depending on volatility, the blue line will lead the S&P 500 by days to weeks. This is how Fred describes it...

Historically, when the blue line is level or decreasing, it typically means any gains in the S&P 500 stocks were difficult to retain.



These indicators typically tend to be a forward-looking indicator of the market’s behavior by approximately two weeks (e.g., red arrow, 20-Sep-11 to 04-Oct-11) to three weeks. However, during unstable market conditions, the forward time seems to increase or decrease by a factor of at least two (e.g., a month or more; a week or less. The S&P 500 Index and C Fund scales (black line) are on the right. Whether these trends will continue is unknown (question marks). All of these charts are provided for informational purposes only and are not meant to predict future market behavior.

If the blue line is in fact leading the market by a couple of weeks currently, then it looks like we could be heading into a pullback.

I pulled the below info from a report from sentimenTrader.com from last year as we headed into the 3rd quarter earnings season, as we are now. This week is a huge week for earnings as most of the Dow companies report and about 20% of the S&P 500 companies...

"The table below shows how the S&P 500 futures performed since their inception in 1982 when they had reached a three-month high on the day earnings season started. The returns go through the end of earnings season, which averages about 27 trading days.


Chart provided courtesy of www.sentimentrader.com

"The results aren't very good. In fact, they're quite poor, especially since 1987. Since '87, the S&P managed to rally through earnings season only 3 out of 15 times, and sported a median return of -1.2%, with a medium maximum loss of -4.8% compared to a max gain of +1.4%.

"This is kind of picking on it a bit, but we also did not see the Nasdaq 100 confirm the three-month high yesterday. Looking at the instances above, there were four others where the NDX didn't confirm. Those were April '87, October '88, April '98 and July '98. The S&P's median return during those four seasons was -2.4%, negative each time, with a median maximum loss of -6.0% compared to a median maximum gain of +1.7%."

Remember, that was written last year and the S&P 500 has not quite made a new 3-month high this year, but the Nasdaq has.

The TSP Talk Sentiment Survey came in at 42% bulls, 46% bears, for a bulls to bears ratio of 0.91 to 1. That is a neutral reading in a bear market which means the system will remain 100% G Fund for this week.

With this being a busy earnings week, and a busy economic data week, we should have a lot of fun, depending on how you define fun.

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

Tom Crowley


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