As stocks dive, a Merrill Lynch market gauge with a perfect record just flashed a red warning light

Key Points
  • Bank of America Merrill Lynch advised clients Friday that it was time to "sell," amid a session that saw the Dow industrials lose more than 350 points in early trading.
  • Stock-focused funds took in $25.7 billion over the past week ended Wednesday, adding to worries that sentiment has become overheated.
Firm grip on bull market says Deutsche's David Bianco

The frantic dash into stocks has hit a boiling point, causing a reliable indicator from Bank of America Merrill Lynch to flash a sell signal Friday.

High levels of investor enthusiasm can be a bad thing when it comes to financial markets, as too much money can push valuations out of whack. BofAML's historically reliable indicator is pointing to just such a period.

The firm's strategists say overheated bullishness tripped its "sell" indicator Tuesday, in the early stages of what has been a rough week. When all is said and done, technical indicators point to a level of 2,686 on the , which would represent a nearly 5 percent drop from Thursday's closing level, BofAML said in a note to clients.

This is the 12th time that the "Bull & Bear" indicator has indicated a "sell" position dating to 2002, and each time has been accurate, the firm said in a note last week. The average peak-to-trough return is a drop of 12 percent.

That's the bad news.

The firm, however, retains a constructive view on the market, with technical strategists telling clients earlier in the week that the fast start in January bodes well for the rest of the year. Based on the 5.6 percent gain for the first month of the year, history suggests the S&P 500 is likely on its way to 3,000 by the end of 2018 and even could hit 3,100, respective gains of 6.3 percent and 9.9 percent.

Philippe Raimbault | Getty Images

What's triggering the near-term concern, though, is another surge in cash both to mutual and exchange-traded funds.

Stock-focused funds took in another $25.7 billion for the week ended Wednesday. ETFs saw the bulk with $22.4 billion, but active mutual funds again saw positive inflows, at $3.4 billion. Together, the funds have seen investors pour in $102.7 billion already in 2018.

Despite the continued run into equities, bond funds also saw another positive week, taking in $5.7 billion for a year-to-date tally of $37.7 billion.

The trends are all part of a big start to the year for ETFs, which took in a record $79 billion in January, including $42 billion to U.S. stock funds, according to Citigroup.

Stocks, however, are in a rut, with the Dow industrials seeing losses cross 2 percent for the week in early Friday trading. The index was off more than 300 points in the first half-hour of trading Friday.

Despite the pullback, it's been a great run for the market as the Dow has gained more than 31 percent over the past year.

Such pullbacks aren't unusual in a hot market, and many leading market strategists expect 2018 to be a volatile period overall.

Investors, thus, have been spreading money around. Within the big surge to stock funds, emerging markets took in $7.8 billion and Japan attracted $2.4 billion in fresh money, though the U.S. continued to lead with $11.1 billion, the biggest influx in 33 weeks, according to BofAML.

In style, large-caps dominated with $13.2 billion. Sectorwise, tech and financials took in $1.3 billion apiece.