US Markets

Signs growing that an 'autumn top' is brewing in stocks

Key Points
  • Stock-focused funds took in $9.9 billion over the past week, the seventh straight week of inflows, according to Bank of America Merrill Lynch.
  • That brought the year's total to $194.9 billion as investor enthusiasm grows over the bull market.
  • The pattern is now "becoming more consistent with [an] autumn top in risk assets," said Michael Hartnett, chief investment strategist at BofAML.
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The market's stubborn refusal to react to bad news is fueling more concern that the surge in stocks is running out of steam and a top is near.

High levels of investor exuberance are a hallmark of turnarounds. In this case, the enthusiasm is coupled with record levels of complacency and a general feeling that nothing can stop a bull market that began all the way back in March 2009 and has withstood any number of challenges to keep on climbing.

The latest sign comes from the almost unmitigated flow of investor cash into funds that focus on stocks. For years, investors had been pulling money from equity funds, but as of late have been piling back in.

Most recently, equity funds took in $9.9 billion over the past week, the seventh straight week of inflows and a number that brought the year's total to $194.9 billion, according to Bank of America Merrill Lynch.

The pattern is now "becoming more consistent with [an] autumn top in risk assets," said Michael Hartnett, chief investment strategist at BofAML. He said a declining dollar and U.S. growth coupled with a tighter spread between government bond yields and the end of high-yield bonds as a market leader would constitute an "early warning system" for a peak in stocks and something investors should watch.

Hartnett is not alone in his warning of potential troubles for stocks. Bond king Jeff Gundlach is making options bets against the market and the current low-volatility climate.

Wall Street has abounded with calls for a market pullback, which hasn't happened in any meaningful terms in 2017. The year has seen the gain just more than 10 percent, itself defying most predictions that stocks were in for a more modest upside.

That growth may be starting to work against itself.

Bullishness among market professionals, as measured by the weekly Investors Intelligence survey, has eclipsed 60 percent, the highest since February and what historically has been a "major warning" for a pullback.

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Stocks have been buoyed by an earnings resurgence — tracking for 7.2 percent growth in the second quarter as 73 percent of companies have topped Street forecasts — as well as hopes that President Donald Trump's pro-business agenda would snap the economy out of its post-recession doldrums.

However, the Trump agenda has largely stalled in Congress and the higher profit levels have driven higher valuations that some believe are getting too lofty.

Other factors also are at play.

Hartnett believes, as do some of his colleagues, that investors are too sanguine about central bank policy, which is tightening around the world. In the U.S., the Federal Reserve has been on a slow but steady pace of interest rate increases, and indicated earlier this week that it soon will begin shrinking the mammoth $4.5 trillion balance sheet of bonds it accrued while trying to stimulate the economy out of the Great Recession.

"Central bank disobedience [is a] classic euphoria signal," Hartnett said.

At the same time, the market's main measure of complacency, the CBOE Volatility Index, continues to trade around half its historic level.

Still, even while signs are brewing that the bull run is getting tired, few forecast a major dip in the markets. BofAML's own price target for the S&P 500 is 2,450, which implies little downside from the current level.

Andrew Adams, an analyst at Raymond James, remains bullish and said he doesn't buy much of the talk that stocks are in a bubble.

"The melt-up likely bears the responsibility for the uptick in articles we've read and conversations we've been a part of recently about a new bubble in U.S. stocks. Yet, if this really is a bubble (we disagree), it's actually a fairly lackluster 'bubble' compared to bull markets of the past," Adams wrote in a client note Friday.

For historical perspective, Adams pointed out that the S&P 500 has gained 12.5 percent a year during the bull run — a solid performance but nowhere near the bull markets of 1982-87 [20 percent a year and 1995-2000 [26 percent].

"So, while we most certainly believe that we are going to see the stock market fall once again eventually," he said, "we think it's wrong to assume it has to end in spectacular fashion from current levels."