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As Uncertainty Looms, Where Can the Little Guy Go?

Investor uncertainty continues—despite last week's pre-holiday stock market rally—leaving retail investors with an array of difficult choices ahead.

A trader at the New York Stock Exchange.
Photo: Oliver Quillia for CNBC.com
A trader at the New York Stock Exchange.

The surge, which added nearly 650 points to the Dow industrials, came even as fund flows and investor surveys continue to show a considerable level of unease from a market that had just weathered a 7 percent downturn.

Moreover, the rally came amid low volume and at a time when managers were looking to shore up their portfolios for the first half of the year and were forced into a buying spirit.

"Doubting the effect of month- and quarter-end window dressing is a mug's game," Dennis Gartman, hedge fund manager and author of "The Gartman Letter," wrote Tuesday. "The stocks that one needed to show in one's portfolio, whether one had owned them or not, rose; and the stocks that one needed not to show fell. Tech was strong; banks were weak."

In the days ahead Gartman believes bank stocks, in particular large regionals, will rise after being the worst-performing sector in the Standard & Poor's 500so far this year.

But whether investors will want to take on the risk of the only sector to post a negative return in 2011 remains to be seen.

Safe haven plays, such as Treasurys, still could be in vogue despite seeing the 10-year note's yield jump past 3 percent during the stock rally and even as last week's bond auctions were poorly received.

"The average investor just doesn't know what to do," said Jessica Hoversen, fixed income and foreign exchange analyst at MF Global in New York. "The vast amount of uncertainty, ranging from the European periphery to China's debt and inflation, and then back to our shores, leaves the investor in a bit of a quandary and thus still supports safer assets."

Two cross-currents could keep Treasury rates low, even though the U.S. is staring its own debt crisis in the face as Congress debates whether to raise the $14.3 trillion ceilingon how much the country owes to its creditors.

"There are fundamental arguments for the U.S. rate to go higher. The data is improving—that's a positive reason for it to go higher. The negative reason for it to go higher is the U.S. government is facing a technical default," Hoversen said. "That juxtaposition is very interesting. Two factors so opposing, and still producing the same outcome."

The weakened dollar and at least temporarily strengthened euroalso presents a challenge to currrency investors.

Pimco, the Newport Beach, Calif., firm that runs the largest bond fund in the world, is recommending emerging market currencies because central banks there are more likely to support the purchasing power of their consumers.

"We anticipate (emerging market) policymakers will allow their currencies to appreciate in the years ahead as they nurture domestic consumption," said Richard Clarida, PIMCO portfolio manager. "And in contrast to the '80s and '90s, in recent years EM currencies have been less volatile than G-10 currencies. Thus, EM currencies can be attractive opportunities."

Investors are noticing the increasing market complexity and are acting accordingly.

The most recent monthly survey from the American Association of Individual Investors shows allocation towards stocks and stock funds dropping to 59.5 percent, which is around the historical average but on a steady move down. It's the lowest level since September 2010, when the markets rallied after Federal Reserve Chairman Ben Bernanke delivered his Jackson Hole, Wyo., speech indicating the central bank was on its way with more monetary intervention.

"We believe this is going to be a cruel, cruel summer, where we see low equity returns, high volatility and low trading volume," Craig Johnson, senior technical research analyst at Piper Jaffray, told CNBC. "That exactly what we're getting over the last several months."

Looking for Diviine Dividends

Investors have been fleeing risk since the Greek debt crisisintensified in early May and as the sell-in-May-and-go-away effect took hold.

U.S. equity funds have lost $11.3 billion over the past two months, while bond funds took in $13.7 billion in June alone, according to Trim Tabs market research firm. Short interest—or bets against the market—increased to 13.5 billion shares in the first two weeks in June, and is up 5.7 percent since the market low in February.

At the same time, the inflation theme is catching on, with Treasury Inflation Protected Securities (TIPS) accelerating their share of the bond market.

For investors looking at stocks, the options are becoming limited.

JPMorgan Chase strategist Thomas Lee created buzz late last week by releasing a list of cyclical stocks—which would benefit if the economy turned around—that he believes will rise during a summer recovery.

But many strategists are gravitating toward dividend-paying stocks in hopes of generating income as the broader market continues to gyrate.

"Buying the 'market' or indices is actually a futile exercise in the type of trading range environment we have been in—plenty of bear and bull markets, plenty of volatility and plenty of tactical strategies for portfolio managers to take advantage of," David Rosenberg, economist and strategist at Gluskin Sheff in Toronto, wrote in his daily newsletter.

The S&P 500, after all, is trading right around the same area it was on the same date—in 1999.

Reinvesting dividends during that time, Rosenberg said, would have provided a 25 percent return, while buying the entire S&P 500 would have resulted in a loss in real-dollar terms.

"So while the overall pricing in the stock market has been flat point-to-point, there was money in the dividend payout ad money to be made by being in the right sector at the right moment," he said. "This is no time for do-it-yourselfers or buy-and-holders."

Nadav Baum, executive vice president at BPU Investment Management in Pittsburgh, sees companies like Coca-Cola , Johnson & Johnson and Heinz providing solid income streams.

"You have to let your money work for you, and the best way to have your money work for you is through dividend and through dividend reinvestment," he said. "It's about buying the high-quality names, the brick-and-mortar names and to continue to clip the coupon."