Come Out Wherever You Are: Investors Still in Hiding

After a summer of low volume and high gains, the stock market soon will face the challenge of whether it can sustain a rally once the crowd comes back from vacation.

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A market that rallies without a lot of participation is generally standing on shifting ground, at least according to Dow Theory, which uses volume confirmation as a key tenet in testing strength.

With September historically a month where trading activity rises, and when volatility increases, the stock marketfaces a critical test.

"Our macro technical work displays an ominous foreboding which strongly suggests that the powerful summer run in rates, crude and global equities will soon be at end," Richard Ross, global technical strategist at Auerbach Grayson in New York, said in a note to clients.

"With both volume and volatility absent from the advance, and a myriad of major markets and macro proxies steaming into stiff resistance during a period of vulnerable seasonality, conditions are ripe for a rapid risk reversion to the mean," he added.

The "reversion to the mean" prediction is a reference to the belief that stocks will always move back to their long-term averages, whether lower or higher from their present positions.

The Standard & Poor's 500 is trading well above its 50- and 200-day moving averages, suggesting a pullback is in order though the timing and degree are, obviously, uncertain.

"The first couple of days after Labor Day, the market most likely will go down. People will most likely want to take profits," said Michael Cohn, chief market strategist at Atlantis Asset Management in New York. "Everything is hostage to the news flow, and as it stands right now the news flow out of the U.S. has been benign to not-so-bad."

Cohn cited a recent statement from widely followed market bear Marc Faber, author of the Gloom Boom and Doom newsletter, who noted that global central banks have been effective in limiting market drops, and would so again in case of a sharp selloff. (Read More: Marc Faber: Beware, a False Rally May Be Coming)

"There's a floor under this market," Cohn said. "If any bad news flow comes out, the central banks can jawbone this thing into submission."

Still, the unwillingness of retail investors to participate in the rally is striking.

Market volume on the New York Stock Exchange has hit 2012 lows in recent sessions and is about half of where it was for the same week a year ago. Options volume is down about 11 percent, while trading activity at the Chicago Mercantile Exchange is off 30 percent from its 2011 pace, according to financial services firm Keefe, Bruyette & Woods.

Fund flows have told a similar story: Equity funds, including exchange-traded funds, lost another $6.3 billion last week while bond funds took in $3 billion, according to Lipper. Stock funds lost $11.5 billion in the second quarter while bond funds gained $55.4 billion.

"The individual investor is still not in," said Keith Springer, president of Springer Financial Advisory in Sacramento, Calif. "At some point there could be some panic buying by some individuals if they gain confidence. But the average investor doesn't believe in this."

That's unfortunate, according to Thomas J. Lee, chief market strategist at JPMorgan, who anticipates the S&P 500 will rise to 1,475 by the time the presidential election hits in November, before pulling back to 1,430 by the end of the year.

In Lee's scenario, the late-year pullback will come not from concerns over Europe's debt crisis or the perils of Congress failing to hit deficit-reduction targets and sending the economy over the fiscal cliff of tax increases and spending cuts. Rather, he said the market likely will retreat if President Obama wins re-election.

"Investors, in our view, are continuing to underestimate the durability of this rally," Lee said in a note. "Basically, we believe the beta chase underway will be sustained. In terms of timing, we see this high being established before election day and that any further gains from that point would be contingent on a Romney victory."

Springer is advising clients to buy stocks but to move carefully, as he sees the market coming apart next year after central banks are no longer successful in stimulating the market.

"It's not a rising tide raises all boats in this case," he said. "They're being very selective generally, in large-caps, interest-sensitive stuff. It tells you there's very selective buying, which is not what bull markets are made of."

- By CNBC's Jeff Cox