Relentless, is the one word that best describes the stock market’s performance over the past six months.

The Dow Jones rose 54% bottom to top, the S&P 500 rallied 62%, and the Nasdaq  soared 71%.

With down days rare, corrections have been shallow. All in all, there hasn’t been a single correction that reduced the S&P 500 (NYSEArca: SPY) or Dow Jones (NYSEArca: DIA) by more than 6%.

The market’s behavior is right in line with the Trend Change Alert given by the ETF Profit Strategy Newsletter on March 2nd. At a time where investors were inclined to sell, the newsletter recommended to buy long and leveraged long ETFs like the Vanguard Financial ETF (NYSEArca: VFH), Select Sector Financial SPDRs (NYSEArca: XLF), Vanguard Materials ETF (NYSEArca: VAW), Ultra Financial ProShares (NYSEArca: UYG) and many others.

As per this alert, the upcoming rally was to be, “broad and powerful in order to relieve investor's pent-up urge to buy.” Dow 9,000 to 10,000 was later on given as a target range.

The rally has not disappointed. Nevertheless, more and more red flags have been raised over the recent weeks. Even though the market has steadily grinded higher, the momentum of the rally was revealing some cracks.

Chinese stocks, the market who spearheaded the advance for emerging market (NYSEArca: EEM) stocks, had started to tire in August. Even though the iShares FTSE/Xinhua China ETF (NYSEArca: FXI) was able to eke out another high on September 16th, the broader Shanghai Composite topped early August and fell as much as 22%.

More recently, complacency – or lack of fear – had become an issue for U.S. investors. The chart below illustrates the S&P’s range-boundness over the six trading days leading up to yesterday’s Fed announcement. Before the announcement, the Volatility Index or VIX actually dropped below 22.50 for the first time in over a year showing that traders were wasting little time worrying about a decline of any significance.



But the unexpected happens often (more about that in a moment). After the Fed’s announcement to leave interest rates unchanged, the Dow Jones dropped 168 points, while the S&P dropped 20 points. Some consider this a bearish intraday reversal. The reversal showed that the S&P 500 has a hard time breaking through the upper trend-line of this rally.

Combined with today’s follow through selling, the last two days mark the steepest 2-day decline of the entire rally from the March lows.

A similar reversal – a bullish one – occurred for the S&P 500 on March 6th. After falling as low as 666, the S&P rallied 17 points that day to close at 683.

To make matters worse for the bears, the Dow Jones Industrials’ push to new intraday highs yesterday was not confirmed by the Dow Jones Transports (NYSEArca: IYT) and Dow Jones Utilities Averages. According to the Dow Theory, this is a small bearish non-confirmation.

The fact that high beta indexes like the Nasdaq (Nasdaq: QQQQ) and small cap Russell 2000 Index (NYSEArca: IWM) have fallen harder today than the Dow Jones and S&P, shows that investors are exiting higher risk investments at a faster pace than low beta indexes, another bearish sign.

No market analysis is complete without looking at investor sentiment. As mentioned above, the unexpected happens often. In fact, when it comes to investing, the unexpected always happens when hardly anyone expects it.

A historic analysis shows that any major market top was always accompanied by extremely high readings of investor sentiment. Just recently, the percentage of bullish advisors, according to Investors Intelligence, reached the highest reading since the March 2007 highs.

What makes yesterday’s reversal so critical is the potential for stocks to drop much lower than anyone expects. The VIX readings and investor sentiment certainly call for a major correction.

Long-term valuation metrics such as P/E ratios and dividend yields call for a drop even below the March lows. Why? Because historically, the stock market has never bottomed unless P/E ratios and dividend yields have reached rock bottom levels. That’s why the 2002 market bottom proved short-lived.

Just as a patient is not healthy unless the body temperature clocks in at 98.6 degrees, the market is not healthy and ready to recover for good unless valuations (P/E ratio, dividend yields, etc.) are reset to fair valuation levels. In short, stocks are still over-valued.

We may not know whether a major market top was reached yesterday, but we can see that the market is getting tired. The market has shown that it respects the resistance line drawn (and illustrated in the chart above). We shall soon see whether there will be another test of this line or the market is ready to head lower now.

The October issue of the ETF Profit Strategy Newsletter includes a detailed analysis of the market’s current position in history – a big picture analysis. It also includes a target range for the end of this rally and a target range for the ultimate bottom.

Relentless was the market’s recent upturn. How soon we forgot that the decline from the 2007 all-time highs was relentless as well. This selective short-term memory loss could be the perfect set-up for the market’s knockout punch.