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Retail Investors Are Back! But Don't Hit 'Sell' Just Yet

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With the broader U.S. stock market hitting new highs, more retail investors have been tip-toeing back into the stock market. And while history indicates that the return of mom-and-pop investors signals an end to the market rally, this time around more strategists say that calling a top could be premature.

Mutual funds and exchange-traded funds recorded net inflows of $4.5 billion in the last week, according to data from Thomson Reuters' Lipper service, with equity funds accounting for nearly $740 million in total net sales. Mutual funds continued to dominate inflows for the 12th straight week, with inflows of $2.3 billion last week, bringing total mutual inflows to $75.2 billion for the year so far.

The inflow is usually a bullish indicator for markets, especially as outflows have been more common in years following the financial crisis.

"After several years of outflows, we've been seeing better inflows so far this year, and we think we have a ways to go," said John Fox, co-manager of the FAM Value Fund. "It's driven today by people who feel that they've been missing out, but we're still in the early innings of retail investors coming back."

(Read More: Why Market's Best Weapon Could Run Out of Gas)

But for contrarians, retail investors' return to stocks raises a red flag that the markets—which have recouped their losses since the banking crisis—could be close to the end of their rally. This view stems from the unfortunate trend of retail investors who are notorious for "buying high and selling low."

"Everyone is worried that the mom and pops of the world are getting back into stocks, and this means we are sure to peak and crash from here—but I don't think retail investors getting back into stocks will mark a major top," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research. "The thing to remember is stock markets peak at euphoria, and we aren't anywhere close to that. Could it mark a near-term top, sure. But this bull market is alive and could have a lot of life left to it."

(Read More: After April Showers, Market Could Spring Higher)

More than $600 billion was taken out of domestic mutual funds from 2007 to 2012, Detrick noted, and only a fraction of that amount has been put back to work this year.

Still, even as major averages continue to push to new highs, investors have been skeptical about the rally amid uncertainty in Washington and ongoing concerns in Europe.

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"This has been one of the least-loved rallies in the history of the stock market," said Art Hogan, managing director at Lazard Capital Markets. "We're still nowhere near the euphoric days of 1999-2000, and there's more pessimism as we've inched higher—even more so now."

Equity mutual fund inflows were at record levels just before the dot-com bubble in early 2000.

Though Federal Reserve Chairman Ben Bernanke expressed confidence in the economic recovery, the Fed Open Market Committee indicated that it will leave interest rates unchanged near zero and will continue buying $85 billion in debt each month until unemployment falls to 6.5 percent and inflation rises to a 2.5 percent growth rate. The central bank's easy-money policy has helped spur stock prices, leading many experts to hold that no other investment offers the returns of equities.

"Stocks are an asset class of last resort—you need yield that's going to outpace inflation, and you're not going to get that in CDs or most fixed-income vehicles," Hogan said. "And for this rally to continue, you'll need to start to see a shift into the cyclicals."

Further underscoring caution, the first quarter's robust rally was primarily driven by defensive sectors such as health care and consumer staples, while cyclicals such as materials and techs lagged the overall market.

(Read More: Defensive Sectors Can Be Leaders in a Rising Market)

"People are coming into the market, but they're coming in reluctantly and buying the safer stocks," Fox said. "There's still skepticism—whether it's about Europe or Washington, people are just waiting for the next shoe to drop."

—By CNBC's JeeYeon Park (Follow JeeYeon on Twitter: @JeeYeonParkCNBC)

Questions? Comments? Email us at marketinsider@cnbc.com

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  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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