Merrill Lynch market indicator that correctly flashed sell signal last week is still bearish

  • Investors pulled a record $30.6 billion from stock funds, with the largest amount coming out of U.S. large caps.
  • Bank of America Merrill Lynch's bull and bear indicator, based in part on fund flows, is flashing a sell warning for a second week.
  • The indicator has a solid track record, correctly forecasting 11 pull backs since 2002.
  • BofAML said the 2,540 level on the S&P 500 could be a good level to buy.
Andy Rouse | Nature Picture Library | Getty Images

Even after investors pulled a record $30.6 billion from stock funds last week, a contrarian sentiment indicator with a solid track record continues to send a sell signal because investors are still just too bullish.

Bank of America Merrill Lynch's bull and bear indicator first triggered a sell signal Jan. 30. Since it was launched in 2002, the indicator has predicted 11 other pullbacks, which had an average drawdown of 12 percent over three months.

BofAML says the S&P 500 could be headed to 2,540, near its 200-day moving average. It said that level on the S&P 500 and a 10-year Treasury yield at 3 percent would be attractive entry points in coming weeks. The S&P 500 was trading at just more than 2,600 Friday morning, and the 10-year yield was at 2.84 percent.

Through Thursday, the S&P 500 was down 10.2 percent peak to trough. BofAML points out that Treasury yields usually drop an average 52 basis points, but in this correction, they were up 12 basis points.

As investors pulled money from stocks, $4 billion in inflows went into bonds last week, according to BofAML. Of that, Treasury inflows totaling $2.2 billion were the largest in 83 weeks.

The record outflows in stocks included $33 billion in redemptions from U.S. stocks, a record. Nearly half of the outflows, $14.9 billion were from ETFs. Japan had the strongest inflow in 65 weeks, at $2.4 billion and inflows continued into emerging market stocks, at $2.4 billion.

The U.S. outflows were mostly from large-cap funds, $27.1 billion, a record. There was another $3.3 billion from growth funds and $3.9 billion from value funds. Energy, utilities and consumer discretionary sectors saw some inflows, but tech had a $1.2 billion outflow, the largest since August 2015. Health care was also a big loser, with $1.4 billion in outflows, the most since February 2015.

High-yield bonds saw $5.3 billion in redemptions, the 13th week of outflows in 15. But $6.2 billion went into investment-grade bonds funds.

The bull and bear indicator is based on a variety of factors, such as hedge fund positioning, flows in bonds and stocks, equity market breadth, and credit market technicals. Its reading of 8.5 is slightly below last week's 8.6.