Quiet week in economic news with the notable development of the Bank of England adopting Bernanke-style employment level targeting with very British-style caveats. This is big news for proponents of central bank targeting conditions rather than time/vague “conditions”. Of course, no matter how transparent central banks become, those who make their living scrutinizing (and confusing the public on) central bank policy will continue to do so.  This should tell you something about how the financial complex works. The next big policy “event” comes at The Jackson Hole summit at the end of August. Stay tuned.

A few weeks back I noted that the market had the potential to,”shift gears into full rocket mode or sputter out at the 1700 figure and back fill.” So far, it has chosen to sputter out at the 1700 level. We now have more information and can confirm that under the hood,  the market is not as strong as we’d like to see. It is too early to tell if we are in real danger here, but market conditions like usually mean you should ratchet down your risk tolerance: tighten up stops, or move to overall defensive positions. I do not feel that the overall bull run has concluded, but you’ve got to be aware of the warning signs.

One of the warning signs is the $NYAD:

After months of confirming highs in the broad market,  the market internals are looking quite tired. Individual stocks are no longer making new highs at the rate they once were.

Another warning sign is the rotation out of financials:

The chart above is the ratio of $XLF to $SPY. After months of outperforming the $SPY, the $XLF is displaying considerable weakness in relative terms. Not long ago the headlines trumpeted the return of banks thanks to stellar earnings reports. The problem is that the headlines were met with weak price action. The question is: which sector will take its place and do we need a market shakeout to shuffle the deck before something else emerges?

To be clear, I still feel that there are higher prices in our future. My warning is about complacency in the near-term. Odds are the market will digest the divergence and make new high prints. Actually, at this stage of an uptrend, that’s the case around 70% of the time. The problem is that the risk/reward is asymmetric. Best case scenario from here is 3-5% upside, and worst case is 5-15% downside. 15% corrections can be particularly nasty. After such a long run and many great opportunities at favorable prices along the way, it makes sense to protect your gains.

Below is a quick table to illustrate my point. I picked times where the market is 20-days above its 34-period moving average. I asked the system for the results of the trade for the 20-days after these conditions occur.

Oh, and by the way, you just got a sneak peak of a new analytic tool I’ve been developing.  Trust me, this is one of one of the more boring features…

Here are the conditions annotated on $SPY: