All major U.S. indices finished with gains last week, led by the small-cap Russell 2000, which was up 2.2% and moved back into positive territory for the year. Year to date, the strongest major index has been the tech-heavy Nasdaq 100, up 5.9%. Since technology and small-cap stocks typically lead the broader market, both higher and lower, we will view upcoming performance in these two key indices as a barometer of the market’s ability to extend its 2014 advance.

#-ad_banner-#From a sector standpoint, one that I will be watching closely over the next month is consumer staples. My proprietary asset flow metric shows that it has had the largest investor inflows over the past one-week and one-month periods. For perspective, similarly aggressive investor inflows into the energy sector in early March preceded 9% relative sector outperformance versus the S&P 500 between then and now.

VIX Suggests Stock Market Advance Isn’t Over Yet
​In last week’s Market Outlook, I pointed out that the CBOE Volatility Index (VIX) finished the previous week just below its 50-day moving average at 13.01. I noted, “The past three times that the VIX made a sustained rise above its 50-day moving average coincided with the past three minor declines in the S&P 500.”

The VIX managed to remain below its 50-day moving average, indicating increasing investor complacency that helped to fuel last week’s move to new all-time highs in the S&P 500. As long as the VIX remains below its 50-day moving average, currently situated at 12.71, I expect the current broader market advance to continue.

There are some headwinds for investor to consider, however, including second-quarter seasonality, as discussed in last week’s report, and the current bullish extreme in investor sentiment.

Investor Sentiment Warns of Problems Ahead
The next chart plots the weekly Investors Intelligence data since 2007 with a corresponding chart of the S&P 500. This weekly survey polls stock market newsletter writers’ bullishness or bearishness on the market. Because these intermediate-to-long-term-oriented professional trend followers tend to be the most bullish at market tops, the current high reading in the survey is a warning that the 2013 advance may be in its latter to final stages.

Note that previous similar bullish extremes in the survey either coincided with or closely led what have been the most important peaks in the S&P 500 in recent history. However, equally important to note is that this is not a tactical tool that indicates precisely when to sell, but rather a strategic one that indicates when investors should be more aggressive about protecting profits. Once a market top does emerge, there are a number of tactical tools that I will employ to help confirm that.

If the VIX stays below 12.7 this week, it will suggest that the coast is clear for more near-term gains in the stock market. However, frothy investor sentiment warns of the market’s vulnerability to a meaningful third-quarter correction.