Hedge funds are finally starting to believe in the stock market's latest rally, but one analyst warns that any move higher will be fleeting

If this week's CPI data and bank earnings instill a rally in the S&P 500, "we expect it to fail around initial resistance near 4,000," Fairlead said.

• Hedge funds are starting to believe the latest rally in the stock market, according to Ned Davis Research.
• The research firm said asset managers have recently reduced their net short positioning.
• But Fairlead Strategies' Katie Stockton said any rally will be fleeting as the S&P 500 faces tough resistance at 4,000.

US stocks have so far turned a new leaf in 2023, and hedge fund investors are starting to take notice, according to Ned Davis Research.

The S&P 500 is up 3% year-to-date, and is up 13% from its mid-October low. Over that same time period, short positioning among hedge funds and leveraged funds has fallen, according to a Wednesday note from NDR.

That suggests prior skeptics of the stock market in 2022 could be turning into believers in 2023, at least if the data holds steady.

"Institutional investors have been covering their shorts and have their biggest net long position since May 2022," NDR said. "While still below the long-term average of 12.7%, it represents a stark change from six months ago."

Asset managers include pensions, endowments, insurance companies, mutual funds, and hedge funds, so it's rare for the group as a whole to be net short as they were in 2022. But since October, when the stock market bottomed, asset managers have been gradually building up their long positions.

But as asset managers start to buy into the latest stock market rally, technical analyst Katie Stockton of Fairlead Strategies warns that any further rally in equities could be fleeting. That's because the S&P 500 is heading towards a very important resistance level at the psychologically round threshold of 4,000.

Stockton said in a Wednesday note that the S&P 500 is experiencing short-term overbought conditions, which will make it "more challenging for the rally to be sustained, as intermediate-term momentum has fallen off since early December."

While she admits upcoming catalysts could spark a further rally in stock prices this week, the jump higher should be short lived.

"All eyes are on tomorrow's CPI data and Friday's bank earnings, and if they instill a rally, we expect it to fail around initial resistance near 4,000," Stockton said. 

But longer-term, there might be reason for optimism towards stocks in 2023 after the first five trading days of January proved to be positive, according to the note.

"January's seasonality is often referenced as providing cues for the entire year. One well-known phenomenon is that gains in the first five days tend to give way to an up-year 83% of the time (over the past 47 years) in the Stock Trader's Almanac. The S&P 500 did post a gain through Monday, which provides hope this year will capture a bullish reversal," Stockton said.