By Alistair Smout and Danilo Masoni

LONDON/MILAN (Reuters) - The double-digit stock-market rebound after a bruising summer has put European shares back into positive territory for the year, but sentiment around the central-bank-fueled rally remains fragile.

Weak trading volumes, a so-far disappointing earnings season and a focus on reliable dividend payouts rather than blockbuster growth have all contributed to the view that investors are being sucked into a market updraft rather than enthusiastically betting on a cyclical upturn.

Even with European shares getting a fresh lift from a weaker euro on Friday - after U.S. data smashed expectations and fueled bets on tighter U.S. rate policy in contrast with the European Central Bank's dovish stance - growth hopes remain fairly muted.

"We can observe that the market continued to be really driven by what is going on with the central banks. If we just look at the fundamentals of the economy it's very difficult to be very optimistic about equities," Jérôme Schupp, Head of Research at SYZ Asset Management, said.

"We had a very strong month of October after two weak months. I don't expect this positive trend to continue."

There are a few reasons to be fearful. On the investor side, European hedge funds have actually been reducing exposure to stocks while the market has rallied, according to strategists at Morgan Stanley.

This is in contrast to what is happening in the United States, they suggest, adding that the exposure data usually tracks equity performance relatively closely.

Volumes have also been weak. While August's falls were partly attributed to low volumes, October saw even less trade.

The corporate landscape is mixed at best. Third-quarter earnings are expected to decline 4.3 percent from 2014, and 44 percent of companies on the STOXX 600 <.STOXX> that have reported results have beaten expectations. Typically, 49 percent of firms beat expectations.

Strategists at Barclays also find that the recent market rally has been not been backed up by a outperformance in the economically sensitive "cyclical" stocks. Even as bond markets are no longer pricing in deflation, the defensive parts of the equity markets are the ones outperforming.

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"Frustratingly for us, while the overall market continues to closely track the outlook for inflation, style and sector performance has not," the strategists wrote in a note, adding it was different to the rally in the first half of the year.

"This time round, although we have had the rally in the market, we have not experienced the same pro-cyclical rotation within the market. Strange indeed."





TAKE WHAT WE CAN

Even against this underwhelming backdrop, however, there is an overriding feeling that equities may still remain the only game in town - especially for those in search of yield.

High-yielding "defensive" stocks like drugmakers or utilities are especially in favor for their bond-like properties in a low-interest rate environment.

With macro conditions unpredictable and a possible Fed rate rise on the table before the year is out, the "bond proxy" play could be under threat if investors switch back into bonds.

Faced with this possibility, Citi recommends buying firms that return money to shareholders while remaining insensitive to swings in bond yields, such as Novo Nordisk <NOVOb.CO>, Diageo <DGE.L> and Vivendi <VIV.PA>.

Bullish notes from the likes of Citi and Bank of America/Merrill Lynch have cited policy support from the European Central Bank and the generally cautious sentiment as a reason to keep the faith and carry on with a "Buy Europe" strategy.

And many are continuing to believe in European equities, even if they are skeptical over how long the rally will last.

"While the concerns regarding global growth have not yet lifted, as could be seen by the continued pressure on the commodity sector, the renewed willingness of the (European Central Bank) to extend stimulus (has been) enough to dispel the gloom," Clodagh Muldoon, equity strategist at BNP Paribas, said in a note.

"For how long is anyone's guess, but we shall take what we can."





(Additional reporting by Sudip Kar-Gupta and Angus Berwick Editing by Jeremy Gaunt)