It looks like the shaky medium term I’ve been cautious about has shown up. I wrote on April 30: “This pace will surely slow down. . . . I think we’re in for a little more upside, but that we’ll be heading lower in the medium term.”

Indeed, the market rose throughout May (the short term), but stalled when it hit June and is still struggling. Three weeks ago, the Dow gained 1.2% to record highs. Two weeks ago, it fell 1.8% to give it all back and more. Last week, it rebounded 1.6%. This week, it fell 2.1%, its second-worst week this year.

You can see the saw tooth pattern with losses exceeding the previous gains. This is not catastrophic, but is good evidence of the deterioration I expected in the medium term.

At the same time, we find a nearly textbook example of investors getting bullish at the wrong moment. On Monday, Birinyi Associates’s Ticker Sense site published a record bullish Blogger Sentiment Poll, with a full 50% of those surveyed saying they are bullish, 27% saying they are neutral, and 23% saying they are bearish.

Value Line, one of the few investment services I respect, says that “Most of the money has been made in the stock market in 2007, in our view. . . . The equity market, which has come a long way in a short span of time, may need a catalyst to cause it to resume its upward climb.”

Bond yields are rising, making stocks less attractive. The 10-year yield hit a 5-year high of 5.327 last week, and is now poking above its 50- and 200-day moving averages, implying that it has higher to go. If so, that will be a further drag on stocks. Historical data show that from this oversold point in the bond market, both bonds and stocks take more than three months to start meaningful moves higher.

In late April, new highs on the New York Stock Exchange were running 759 per week. A month later, they were down to 618. Now, they’re at 436. The winners list is thinning.

The near failure of two Bear Stearns hedge funds is not dangerous as an isolated event. However, if it’s a window into a slew of meltdowns related to the sub-prime implosion, then it could be the catalyst that sends this market to the mat.

Already high gasoline prices are apt to keep moving up due to several factors: U.S. refineries are operating at just 89% of capacity instead of the usual 92% this time of year, OPEC will not lift its output levels, and there’s a good chance of trouble from geopolitical sources and hurricane season.

The economy is doing well, but some are focusing on the negatives of its soft landing. Signs of an economy not growing fast enough will cause pain now, but will keep inflation under control and allow greater growth later. This is not the end of the bull market. It’s an adjustment lower along the greater path higher, and should be used as a buying opportunity.

That’s what I plan to do. I’ll keep watching The Kelly Letter’s short list of stocks for the right time to buy, and others, too. On a recovery, I will look for a time to open a hedge position to protect our portfolio from falling prices.

It’s been a while since I’ve sent a mid-week action note, but I told subscribers this weekend to keep an eye out for one. There’s a chance we’ll be served some hot-iron opportunities that won’t wait for a weekend note. If you’d like to join us for a month to receive any such notes, please do so here.

We’ve done well in the first half of the year. We did not get overly cautious when others were warning of impending disaster, we did not shy away from troubled companies when their stock prices hit our price targets, and we’ve been patient in calling this medium-term setback. I hope to navigate the medium- and longer-term pictures with equal skill, and am privileged to be able to do so for my subscribers.

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