BOSTON Even as U.S. blue chip stocks hit a record high on Tuesday, a Bank of America Merrill Lynch analyst cautioned that a sell-signal may be forming that might spoil the party, if only briefly.
Mary Ann Bartels, a technical research analyst at the bank, said in her weekly Hedge Fund Monitor note that lower cash levels in margin accounts could suggest a sell-off lies ahead.
But Bartels and her team of analysts, who track how many of the world's most powerful hedge funds are positioning themselves, said any future decline could just be a short-term correction in a market that has become a little too excited.
The bank's research note was released on the same day the Dow Jones industrial average steamed to a record high, topping the record close of 14,164.53 set in October 2007.
"Current levels have fallen to levels that have generated a tactical sell signal based on a 2-standard deviation Z-score reading." Bartels wrote, referring to cash balances in margin accounts.
What happens next could be similar to what happened nearly three years ago, she added.
"The last time a sell signal was generated was on April 2010, and the S&P 500 subsequently corrected by 16 percent in the two months."
But there are also signs that stock market investors have become significantly more confident over the last years and that any sell-off may only be a brief correction, the analysts said.
Investor confidence is measured by how much more borrowed money is being used to finance trades, the bank said, noting that leverage rose 31.6 percent year on year and 10.2 percent month over month to $364 billion in January, compared with a peak of $381 billion in July 2007.
"Current readings indicate that investors are becoming more confident in the equity market, which generally supports further upside," the note said, adding, "Just short term levels have gotten a bit ahead of themselves with cash levels now drawn down to levels which typically result in market correction."
Although some hedge funds have delivered eye popping returns over the years, the $2.6 trillion industry is off to a slow start in 2013. "Hedge funds continue to underperform the equity market," the note said.
With hedge fund returns closely guarded by their managers, only a few numbers have dribbled out in the last days.
Tiger Global Management, whose past double-digit returns have ranked it among the industry's best performers, is among the funds that got off to a tepid start. The fund inched up 0.3 percent in February and is now up 2.3 percent for the first two months of 2013, an investor said. The Standard & Poor's 500 index climbed 6.2 percent during the same time.
The bank's research also found that certain hedge funds, particularly so-called global macro funds that bet on currencies and interest rates, have aggressively bought the Standard & Poor's 500, NASDAQ 100 and 10-year Treasuries.
At the same time, they aggressively sold commodities. But the bet on 10-year Treasuries is already crowded, the bank found, perhaps suggesting some concern about how quickly the global economy will continue to recover and that spending cuts might weigh on U.S. growth.
(Reporting By Svea Herbst-Bayliss; editing by Andrew Hay and Leslie Adler)