Stocks Will Keep Rollin' in '07

Many strategists are expecting a less robust version of 2006, when the stock market was led by different groups at different times. At the start of the year, cyclicals, energy and small-caps led the way. When the market hit a peak in May and then sold off, many investors were prompted to rotate into more-defensive stocks, including large-caps, consumer staples and health care. But after the market's double bottom in June and July, the rally gathered steam again, on the back of the old small-cap, energy and cyclical leadership.

By the end of the year, investors who expected a correction and missed the late-summer rally started to panic and put their sidelined cash to work. Until the week of Dec. 18, the tide had risen nearly across the board as everything from mega-caps like Microsoft and Exxon Mobil(XOM Quote) to the small-cap Russell 2000 to the typically humdrum, defensive Dow Jones Utility Average made 52-week highs.

"I think it is prudent to give the stock market the benefit of the doubt right now," says Jeffrey Knight, chief investment strategist at Putnam Investments, which has $191 billion under management. "It is hard to see where the imminent vulnerabilities [are] today, but that doesn't mean they don't exist."

The biggest threats to the stock market are a liquidity crunch and a slip into recession, and "traditional diversification may be inadequate or less powerful than in past cycles to protect against a downturn," Knight says. "But it is hard to intellectually make your scary scenarios your central case."