The ‘Most-Hated Stock Rally’ Could Be Primed For A May Correction

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Despite a flat day for stocks on Friday, the S&P 500 and the Dow are enjoying a stunning bull run that has them approaching records set back in May.

However, this climb toward fresh heights may be ephemeral, according to technician Tom McClellan. In a series of notes, he said the stock market is nearly out of room to run higher because such a large swath of investors have already “turned bullish” over the past several weeks.

“If ‘everyone’ is already bullish, then there is no one left to turn bullish, and to add incremental buying pressure to lift prices. That is the basic point behind why traders like to watch the various measures of investor sentiment,” McClellan said in a note to clients dated April 19.

Indeed, sentiment as measured by the National Association of Active Investment Managers, which puts out a weekly survey gauging investor exposure to stocks, is at its highest level since April 2015, as the following chart shows:

To put that into perspective, investors are more bullish now than they were ahead of the China-fueled August stock-market correction that wiped out more than $2 trillion in stock value and erased the benchmark’s gains for 2014 and 2015.

But since Feb. 11, stocks staged a fantastic recovery, with S&P 500 SPX, +0.00% and the Dow Jones Industrial Average DJIA, +0.12% both nearly up 15% over that period. The small-cap Russell 2000 RUT, +0.96% , which had previously slipped into a bear market, officially returned to bull territory with Friday’s close, rising 20.23% from the February 11 closing low.

The stock market rally has also coincided with the low for West Texas Intermediate crude-oil prices CLM6, -1.33% which has soared 66% since that February bottom. That run may have eased some fears that imploding oil futures would capsize global markets, which are still wrestling with stubbornly low levels of inflation.

Skittishness about the staying power of these gains is probably why McClellan notes that the has been called “the most hated rally.”

The technical analyst also points to investor complacency, as measured by the so-called fear gauge, the CBOE Volatility Index VIX, -5.23% which was at 13.41 late Friday, was near its lowest level since August when it was at 12.51, before surging to 53.29 as the market unraveled and fear was rampant.

“Sentiment is an interesting thing,” Peter Boockvar, chief market analyst at the Lindsey Group, told MarketWatch. “You have to question and doubt the sustainability of this rally.”

Skeptics, meanwhile, have focused on expectations for lackluster-to-woeful corporate quarterly results.

“There are headwinds that have just been put aside since mid-February. The global environment is beginning to slow and that’s being reflected in crappy earnings,” Boockvar said.

On Friday, disappointing earnings from Microsoft resulted in the tech giant shedding nearly $40 billion in value. But so far, earnings have generally surpassed lowered expectations, buoying markets. That left the Dow with a 0.6% weekly gain, while the S&P 500 posted a 0.5% rise.

As MarketWatch’s Wallace Witkowski wrote, the price-to-earnings ratio for the S&P 500 index is about 18 times trailing 12-month earnings, which investors view as expensive considering the aforementioned weak earnings and the fact that stocks have gone pretty much nowhere over the past year.

Concerns over the future of the stock-market rally come as this current bull market rally that started in 2009 prepares to enter its seventh year on April 28, which would make it the second longest bull market after the 13-year rally that ran from 1987-2000.

But based on the growing sense of nervousness, investors might be at a crossroads. And there are tons of gloomy predictions surfacing from those who don’t put a lot of credence in this run-up.

For one, Stephen Kalayjian, chief market technical analyst at research firm KnowVera is predicting stocks to reach a peak in mid- to late-May and selloff from there.

“There is significant amount of overhead resistance in the U.S. equity markets. The markets are showing signs of exhaustion up at these current levels, Kalayjian said in an April 13 research note. McClellan is also expecting a slide to begin around May.

Of course, not everyone is expecting rough seas ahead. Jeffrey Saut, chief investment officer at Raymond James, is describing the recent action as a “buying stampede,” and is convinced the market is on track to break new records.

Saut defines a so-called buying stampede as 17 to 25 days of up days, only interrupted by no more than three down days. He said the market was in its 49th day of this buying phase and cautioned “not to doubt a buying stampede.” “I haven’t wavered in my view of the market…We came in cautious but I think this [stock market] trades higher,” he said.

So, sell in May and go away? Or dig in with both hands? It is anyone’s guess, but there are reasons to move gingerly with the Federal Reserve set to update its interest-rate policy on April 27 at the conclusion of its two-day policy meeting.