The market rally continues. Traditionally the months of September and October are weak as we head into the third quarter earnings season. This year these months have been the exact opposite. Expectations for a new round of quantitative easing (QE) by the Federal Reserve has crushed the dollar and fueled big gains in commodities. Extremely low interest rates are making stocks look cheap by comparison. Unfortunately the economic data continues to come in mixed and we're not seeing any improvement in unemployment.

On Friday the New York Empire State manufacturing survey was bullish. The report showed an increase from 4.1 in September to 15.7 in October. Numbers above zero indicate growth and expansion and economists were only expecting a jump to 6. Counteracting the bullish data from New York was the disappointing consumer sentiment figures. The preliminary University of Michigan sentiment reading slipped from 68.2 in September to 67.9 in October. This was the weakest reading since July and the future buying plans component turned lower, which doesn't bode well for consumer spending.

At the same time the Commerce Department said September retail sales improved. August saw a +0.4% increase and economists were expecting the same +0.4% in September. Yet the government revised August higher to +0.7% and said September sales rose +0.6%. This is a very positive reading and suggests consumers attitudes may be sinking but they're still spending. On a similar note the National Retail Federation released an upbeat forecast for this holiday season, suggesting it could be the best Christmas season in the last four years.

One of the biggest headlines on Friday was Fed Chairman Ben Bernanke virtually confirming a new QE program with his comments in a speech he gave in Boston. Bernanke stated that there appears to be a case for "further action." Now the market has been enjoying a little QE euphoria lately with investors acting like the Fed has a placed a put option under the market (will buy the market if it goes down). Expectations for further QE has pushed the U.S. dollar to new eight-month lows and gold to new all-time highs and silver to new 30-year highs. The dollar's drop is alarming and countries like China are getting irritable and there is talk of a currency war as nations talk about devaluing their currencies to stay competitive in the export market.

A big question to ask is, "at what point is the QE news already factor into the stock market?" We've seen a pretty strong advance and some form of QE is already baked in. The market could see a "sell the news" reaction to any QE announcement no matter what the Fed says. There are growing concerns that the Fed's next QE move may not be big enough. Most are estimating the Fed to unveil a $500 billion to $1 trillion QE program although some analysts have suggested the Fed may leave it opened ended and without a cap.

Another challenge for the markets is the financial sector. Banking stocks have been a real drag on the markets this past week as investors worry over the foreclosure liabilities. This robo-signer scandal has raised questions over fraud. There are investigations over potential fraud in the actual foreclosure process and potential fraud in how these mortgages were marketed and securitized to begin with. Big investors who bought these mortgage-backed securities could sue the banks to buy them back if they can prove there was fraud involved. At the same time the current moratorium on foreclosures from BAC, JPM and GMAC Finance doesn't help matters. Any delays in the foreclosure process keeps these bad loans on the books, impacting bank profits and reserve requirements. Plus, any delays will significantly hamper the housing market pushing any recovery further and further into the future. There are some estimating that the banks liabilities could be in the $80 billion range. We know from JPM's recent earnings report that they are expecting more litigation as they increase their litigation reserves by another $1.3 billion.

There is a very real risk that this foreclosure issue could be the unexpected event that knocks the market back into the double-dip recession but I'm not giving up yet. Plus, long-time readers of this column already knew we were facing a tidal wave of foreclosures in 2010 and 2011. Speaking of which, RealtyTrac just said bank repossessions in September hit a new all-time high with more than 100,000 homes foreclosed by the banks.

Technically the market remains the same. Stocks are up, the dollar is down and commodities are surging to new relative highs. It's starting to look like this dynamic might actually change soon. While any QE program will continue to erode the value of the dollar, on a short-term basis the dollar is so oversold that it looks like it could see a bounce soon. That should spark some profit taking in commodities and stocks.

The S&P 500 is hovering near resistance around the 1173-1175 zone. If we see any sort of pull back I would look for support near 1150. Additional overhead resistance is probably the 1200 level and then 1220. The NASDAQ continues to surge and climbed to new five-month highs on Friday but this move is being fueled by just a handful of huge big cap names hitting new highs like GOOG, AAPL, and AMZN. This move is very evident in the NDX (NASDAQ-100 index), which actually broke out to new multi-year highs on Friday's rally. If you're just looking at the charts this rally in the NDX is a very bullish signal but the rally is going to run out of gas eventually. GOOG surged $60 (+11%) on Friday to $600 a share. How much higher do you think it's moving on Monday? AAPL could see a big spike higher on Monday-Tuesday this week as the company reports earnings but what are the odds AAPL will see some post-earnings profit taking?

Daily chart of the S&P 500 index:

Daily chart of the NASDAQ index:

Weekly chart of the NDX (NASDAQ-100 index):

Like I said, eventually this rally will stall and correct. That's okay. It would be healthy and allow us a potential entry point to pick trades heading into the fourth quarter. On a short-term basis the focus is going to be on earnings and the elections. This coming week is a huge week for earnings news with hundreds of companies reporting. Plus, we're down to just two weeks before the midterm elections. I would still like to see some sort of pull back in the second half of October but I'm a lot less confident that will happen. We can't forget that mutual funds are facing their fiscal yearend on October 31st. Given the market's gains and resilience I'm sure a few of them are feeling the need to chase stocks higher.

- James