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Markets 'Flashing Orange' But Investors Still Taking Chances

The stock market's shaky performance at the start of 2010 hasn't convinced investors yet that it's time to pull money wholesale out of stocks.

Monday's stock rally was clear evidence of an emerging trend for the year: a cautious approach that features buying when the market looks undervalued and selling at key technical resistance levels.

After a hugely positive 2009, this year is shaping up as a steadfastly cautious time.

"The markets are flashing orange, orange, orange," says Kathy Boyle, president of Chapin Hill Advisors in New York. "There are critical levels that everyone's watching."

Indeed, stock pessimists made a compelling case for a correction even among Monday's solid gains. Strategists said that while the indexes moved strongly positive, sellers stepped in before the surge got out of control.

Somewhat chillingly, technicians noted that the Standard & Poor's 500 has broken below its 80-day moving average for the first time since March 2009, which also marks the oft-cited most recent low for the market and the barometer by which the current rally is measured.

"This intermediate trendline acted as resistance on rally attempts during the last seven months of the 2007-2009 decline," Todd Salamone, senior research analyst at Schaeffer's Investment Research, pointed out in a research note.

"A crossover above this trendline in March 2009 proved to be a 'buy' signal, and pullbacks to this moving average in July and October 2009 were excellent buying opportunities, "Salamone said. "The (S&P) has now closed below its 80-day moving for six consecutive days, and has resisted attempts to close back above it in each of the past five days."

Investors are taking note.

Fund flows for the week ending Jan. 27 showed US equity funds with outflows of $1.17 billion, according to AMG Data Services. Yet that number comes with a caveat—money market funds had outflows of $19.8 billion, demonstrating that investors are tiring of safety positions and looking to put money to work.

Economist and noted market bear David Rosenberg, of Gluskin Sheff in Canada, told clients Monday that "it's not too late to switch to a defensive posture" and advised clients to watch emerging market and dollar trends.

Beyond that, he noted that the market in the past several years has shown a convincing trend in which sectors reverse roles each year.

"It is interesting that heading into 2008 all you had to do as an investor was flip everything around from market performance in 2007—across just about every asset class," Rosenberg said. "Then in 2009, what you wanted to do was the exact opposite as what worked in 2008.

"Here we are in 2010 and it seems to us as if, yet again, what worked the year before is not going to work in the coming year and vice versa."

Buttressing Rosenberg's point is that technology led the S&P last year with a 61 percent gain and is near the top of worst performers with an 8.4 percent decline. Yet telecoms lagged last year and are the top laggard on the broad index. At the same time, the dollar tumbled in 2009 but is stronger in 2010.

Winterizing Your Portfolio - A CNBC Special Report
Winterizing Your Portfolio - A CNBC Special Report

Hence, the call from various quarters to step lightly through the market minefield this year.

Ticonderoga Securities analyst John Stoltzfus is sticking to his advice to "hedge the cyclical and fund the secular—remaining constructive on the economic recovery here and abroad but keeping wary of the performance gap that remains between the economic recovery versus valuations and respective prices of stocks and commodities.

"We'd expect that markets could likely move sideways to lower near term notwithstanding any bargain hunting off last week's action in today's session."

Such uncertainty about even a fairly robust rally like Monday's suggest that investors will have to keep eyes peeled in all directions, particularly Washington, where eruptions about big-bank clampdowns and gridlock loom above Wall Street.

"Elegant outcomes are not something typically manufactured at the end of Pennsylvania Avenue in Washington, D.C., but it looks like this year we need exactly that," Credit Suisse said in a research note skeptical about the near term in stocks. "While we eagerly watch and wait for the outcomes of this high-stakes legislative process, it is very likely that equity risk premiums rise as excess liquidity fades."

It adds up to a tough year for investors looking to put money to work.

"We believe the easy money was made last year as the markets rebounded from the lows last March through December," Stoltzfus said. "This year's money will have to be earned the old-fashioned way."