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The market pulled back some today after reaching milestone levels not seen for 6 years, but the momentum remains firmly in place to scale the 2007 heights. We are in somewhat of a quiet period over the coming days, with most of the major economic and earnings data already behind us. This may come in the way of the market's ever-higher thrust, but wouldn't be indicative of a material trend reversal.

Market participants seem genuinely happy with how things are shaping up. Some potentially problematic policy pitfalls like the 'Fiscal Cliff' and debt ceiling have been avoided or deferred for the time being. The U.S. economy is showing signs of health, China seems to be in good shape and even Europe's situation may not be that worrisome. The fourth quarter earnings season currently winding down may not be showing a lot of growth, but that should show up in the coming quarters as the economy's growth momentum resumes. Bottom line, the economic and earnings picture may not be in great shape at present, but the outlook on both counts remains strong.

But is the outlook for the economy and corporate earnings really that robust for stocks to be on the cusp of new all-time highs? As regular readers know I have been, and remain, skeptical of the positive narrative for the market. While I acknowledge the few positive factors, both here in the U.S. as well as abroad, the overall gains in the market remain unsupported by underlying fundamentals.

In this piece, I want to survey the landscape of bullish and bearish arguments to help you make up your mind as to which carries more weight.

Let's talk about the Bull case first.

1) Robust Domestic Economic Picture: Adjusting for the temporary factors that held down economic growth in the fourth quarter GDP report last week, the economy is in pretty good shape. Friday's jobs report is not the only evidence in support of this argument; the manufacturing data has started looking up again and the housing market is steadily improving. This means that GDP growth should move above the recent below-trend growth in the second half of the year and continue ramping up next year.

2) Supportive International Backdrop: Europe isn't resolved yet, but the threat of global financial turmoil resulting from the currency union's breakup has clearly been averted. Yields on Spanish and Italian government bonds have come down to more reasonable levels, and one could safely assume that the region will eventually reach some resolution to its structural problems. The outlook for China has clearly improved and fears of a 'hard-landing' have proved to be exaggerated.

3) The Still Favorable Earnings Picture: Contrary to pre-season doomsday scenarios, corporate earnings are not falling off the cliff. Granted, growth has been on the light side, but that should change in the coming quarters as earnings are expected to grow close to 8% in 2013 and more than 11% in 2014. The market is much more interested in what companies are expected to earn in the coming quarters, rather than what they earned last quarter. And on that count, the picture couldn't be better.

There are plenty of other arguments too, ranging from valuation calls to the very supportive Fed to new money flows into the equity markets.

But let's see what the Bears have to say in response:

1) Market is Pricing a Best-Case Scenario: Market prices reflect consensus expectations and current consensus expectations for GDP and earnings growth are clearly on the optimistic side. Granted the Q4 GDP report was held down by factors that should be discounted and there is some momentum on the household and business spending fronts. But that is an argument for keeping the economy afloat in the +1% to +2% growth range and not a basis for above-trend growth in the second half and beyond. Even assuming that the budget sequester is adequately resolved, we have to acknowledge that we are going through an extended period of sub-2% GDP growth at best.

2) International Backdrop Not Growth Friendly: Europe may no longer pose contagion risk, but its economic struggles will remain a drag on global growth for quite some time. The region's economy remains in recession and is unlikely to become a growth contributor, or even less of a drag, as the consensus outlook is currently projecting. In fact, it is more than likely that Europe's problems will drag down Germany's economy with it. Stabilization of Europe is also critical to many of the emerging markets, particularly China, which will continue to struggle in resuming 'normal' growth in the absence of European demand. China's economy may have stopped decelerating, but it isn't going back to its historical double-digit growth rates either. The outlook for other emerging markets like India and Brazil is far weaker.

3) The Earnings Growth Cycle May be Over: The better-than-expected fourth quarter reporting season shouldn't distract us from the fact that the earnings picture is hardly in good shape. Yes, roughly two thirds of the companies are beating earnings expectations, and total earnings growth is positive and better than the preceding quarter. But strip out Finance's flaky earnings and total earnings growth turns negative.

Importantly, expectations of strong earnings growth in 2013 and 2014 remain way too optimistic and unlikely to come to fruition. The market is looking for a combination of further margin expansion and revenue gains to drive earnings this year and next. But margins have already peaked and revenue growth is hard to come by in the growth-constrained global economy. The best we can expect on the earnings front will be something along the lines of what we got in 2012 – growth of +3.7%. One could make a plausible case for negative earnings growth this year and next, but the most likely scenario is low single-digit growth.

Putting It All Together

As regular readers know, the bearish case makes more sense to me than the alternative. Simply put, I find it hard to envision stocks holding their ground beyond the current period of misplaced optimism. There is no need to panic and get out of the market altogether. The way to go is to lower your risk profile by reducing your exposure to high-beta and economically sensitive industries and staying more defensive.

Focus List Update

We did not make any changes to the Focus List this week, but I do want to emphasize that you should be using the Zacks Rank as your primary stock-selection tool to defensively position your portfolio.

I mentioned the energy MLPs on the Focus List last week as an example, but you can take a look at the REITs, healthcare stocks and even utilities that we have in the portfolio. We have four REITs on the Focus List with Ventas (VTR - Free Report) and Simon Property (SPG - Free Report) still having Zacks Rank #2 (Buy), while the other two are currently Ranked #3. Even two of our three electric utilities DTE Energy (DTE - Free Report) and Wisconsin Energy (WEC - Free Report) are currently Ranked # 2. Many of these stocks haven’t run up as much as some other sectors and still offer plenty of value, not to mention highly desirable protection.

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