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Market Preview: Cautiously Optimistic

NEW YORK ( TheStreet) -- Even bullish calls sound a bit bearish these days.

Citigroup went to overweight on U.S. equities on Wednesday, citing expectations for "solid" earnings growth and the easing efforts of the Federal Reserve. The firm also downgraded Japan, advised investors to "avoid" Continental Europe, and said it's overweight Asia excluding Japan and Australia. But the call carried some caveats as Citi said the global profits cycle is "clearly slowing."

"The bad news for global equities is that profits are slowing around the world and EPS expectations need to be cut further, in our view," the firm said. "The current downgrade cycle is not over. The good news is that equity valuations remain cheap and central banks are prepared to embark on additional easing."

The argument has been made that since it's well known that third-quarter earnings season will be weak, the impact of disappointing results will somehow be lessened but Citi still thinks there's plenty at stake.

"It's still a macro-driven market -- We believe investors should be braced for a choppy 3Q12 earnings season, punctuated with cautious commentary and tepid topline growth due to macro slowing," the firm said. "The key will be discerning how this weakening scenario is already priced in and whether the market is willing to look through a soft 4Q12 as well."

In this kind of environment, stock picking gets emphasized (rather than index-based investing), and Citi said it likes "higher-quality, late-cycle names, with better earnings visibility, including General Electric (GE), Honeywell (HON), and Danaher (DHR)."

"We expect the collective macro pressures in Europe and China, tougher comps for US growth + Fiscal Cliff worries, and the tempered growth outlook to dominate earnings season," the firm said. "Historically, 3Q is the sector's most lackluster quarter and we believe the setup should be mostly consistent with seasonal 3Q patterns with a relatively flat stock price performance."

One group that's being pretty open about its growing bearishness is the retail investor. The latest sentiment survey from the American Association of Individual Investors found just 30.6% of those polled were bullish about where stocks are headed over the next six months, down 3.3 percentage points from last week.

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