After my uncharacteristic post about finding a bottom in the markets at the end of June, I’m going back to check the same indicators to see whether or not they imply an interim topping point could be at hand.

In a rising market, the Bullish Percentage normally tops out above 70%. As you can see from the chart, successively lower peaks have coincided with intermediate market peaks – the reason you should shorten up long trading positions in bear markets. In itself, this still looks to be too low to justify calling a top.

The percentage of stocks trading above their 50-day moving average typically rises above 75% before the market reverses course. With less than half of stocks above that mark presently, there are still many stocks that are beaten down.

The percentage of stocks above their 200-day moving average tends to peak above 70%, though it too has topped out at lower and lower ranges as the bear market has unfolded. Still, the overall low score suggests more upside.

Likewise, the McClellan Summation is still negative, but rising. This is supportive of further rallying.

Supporting these readings, the VIX is moderating in the low 20s, though its effectiveness as an indicator might be impaired in markets like this, as I’ve discussed before.

With the indicators implying that the trend remains higher for the time being, what are the likely causes that could bring an end to the rally party?

A very simple way to end the party would be if financial institutions took advantage of their newly higher equity prices and did additional dilutive equity offerings. For example, I can’t focus enough on how Wachovia (WB) continues to drag out the bad news – this time of an extra $500 million loss provision – and I continue to be puzzled by how they can provision for less than their existing nonperforming assets. Again, US Bancorp (USB) has allowances for 270% of existing nonperforming assets, Wells Fargo (WFC) has 184%, Bank of America (BAC) has 187%, and Wachovia has 90%. Um hm. I noted previously that it would take another $1.25 billion for Wachovia to true up and match their allowance to their existing nonperforming asset base, but it’s apparent that the truly well-capitalized banks suggest about twice Wachovia’s existing provision is appropriate. That would require just short of $11 billion, and with $36.2 billion in tangible equity on the balance sheet at quarter’s end, and that could spell trouble.
Alot of this rallying depends on how well the market can bounce back from JPMorgan’s (JPM) announcement of $1.5 billion in mortgage security losses; perhaps it’s the optimist in me that sees that amount as not enormously significant, and views the sell-off in the investment banks today as sign some healthy fear remains in place.

Another point of note is that as oil and gas prices have come down substantially, the retail ETF (RTH) has finally caught a bid; most of the up move has happened in the last few days. My main concern here is that consumers won’t have an immediate reaction to falling pump prices, and thus same-store comps next time around still won’t be anything worth celebrating, and cause the strength of the consumer to fall further into the realm of questionability. Coincidentally, retail sales are reported… tomorrow.

While I don’t believe the underpinnings of this rally are exceptionally strong – the leadership of poorly performing financials who are likely to turn around and use the rally to issue equity is less than ideal – I also believe that enough other people are still negative that the market could push higher another 4-5% before things get overly extended. At that point, you’ll likely hear more people come out of the woodworks with surprisingly optimistic view of the economy…

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