Friday Look Ahead: Stocks Side Step Rate Rise as More Bullish Forecasts Grow

As the equities market quietly side steps this week's jump in interest rates, Wall Street prognosticators are issuing more bullish forecasts for next year.

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Barclay's Capital Thursday said it sees the S&P 500 at 1420 in 2011 and expects a good environment for stocks for at least the next couple of months. Goldman Sachs also recently released its forecast, and it sees a more than 20 percent increase next year to 1450 on the S&P 500.

"I am somewhat wary of the fact that most of the strategists are bullish as well," said Barclay's Capital's Barry Knapp, as he wound up a press briefing on the firm's outlook.

"The first half looks like it has a better backdrop for the equities market," he said. Knapp said he favors U.S. and European stocks over emerging markets in 2011 because the gap between growth rates in the developed markets and the faster growing emerging markets is narrowing.

He expects 9 percent U.S. earnings growth and continued margin expansion in 2011. He also expects revenue growth to be about 5 percent, higher than nominal GDP due to the boost from foreign sales.

Knapp, who heads equities portfolio strategy, also changed his view on financial stocks. "I'm not ready to say it's all clear" for the group, but he has put them at market weight. Financials have been gaining favor as a undervalued group, as more investors see them as neglected and a recovery play.

The KBW banking index is up 5 percent this week, as traders also bet a steepening yield curve would help bank profits. Year-to-date, the S&P financial sector is up just 8 percent, compared to the richer moves of 20 percent for industrials and 25 percent for consumer discretionary stocks.

The S&P financial sector rose 1.3 percent Thursday, the best performer in a market that was barely changed. The Dowwas down 2 points at 11,370, and the S&P 500gained 4 to 1233. The Russell 2000 was up about a half percent to 767, its highest close since December, 2007.

As strategists set their 2011 stock market targets, economists have been raising their growth forecasts. A major catalyst this week has been the tentative tax deal announced by President Obama that would extend all Bush-era tax cuts for two years and add a new one-year tax break on Social Security taxes.

Pimco raised its growth outlook to 3 to 3.5 percent for next year from 2 to 2.5 percent because of the hefty stimulus push, according to CEO Mohamed El-Erian.

"Maintaining such a growth rate beyond 2011 requires additional measures to enhance competitiveness and achieve medium-term fiscal consolidation," he wrote in a quick note.

Bond market steadies

Traders say the better outlook for the U.S. economy has been a big driver of interest rates in the past week, but at the same time the market is reacting to the fear of growing U.S. budget deficits.

The bond marketquieted down somewhat Thursday, and the auction of $13 billion in 30-year bonds went smoothly.

The 10-year yield slipped to 3.228 percent, but not before a volatile 5 bps move as the Fed made a late morning announcement on its purchases of Treasury securities. The dollargained 0.15 percent against the euro, to 1.3243. Gold recovered some of Wednesday's losses and gained 0.7 to $1392.10 per ounce.

"I think we're going to be in a range trade, probably for the next two weeks," said Jefferies Treasury strategist John Spinello. "I think 3.40 (10-year yield) will be the upper end of the range into the week after next..I think the corrective rally we'll go through could take us to 3.10, 3 percent."

Spinello said the big move around the Fed's announcement Thursday, coincided with a big sale of 10-year futures.

Knapp does not see the move in rates as an obstacle for stocks for now, and he expects the Fed's purchases of Treasurys to help keep rates from rising too much.

Steve Massocca, managing director at Wedbush Equity Management, said the current move in rates might actually be good for stocks. The 10-year yield at "3.25 isn't enough to draw new money into bonds, but it's high enough to scare money out and into equities," he said. "The psychology of this move is one that prompts selling in bonds, not buying in my opinion."

Knapp still sees plenty of potential headwinds for stocks next year, including the possibility of a new chapter in the European sovereign debt crisis. "Their banking system is at at least six months, if not a year, behind ours," he said.

"I think Europe is going to struggle with these major issues for some time," he said. Another headwind will be the U.S. deficit situation, which he expects will periodically get attention and become a problem for stocks.

Knapp said there could also be concerns by the mid-first quarter that China's tightening has gone too far.

What to Watch

Speaking of China and tightening, markets had been watching for a rate hike from China over the weekend, but there's some sense in the foreign exchange market that the move could come on Friday.

"China's news is supposed to come on Saturday when the CPI data is out, unless it is leaked tonight," said David Gilmore of Foreign Exchange Analytics. "I guess we could get a rate hike Friday in China. I would not rule it out. It would probably be announced pretty late in our day." Gilmore said there have been rumors that Chinese CPI would come in at 5.1 percent.

In the U.S. Friday, there are several economic reports to watch. International trade and import prices are at 8:30 a.m., and consumer sentiment is released at 9:55 a.m.

In Europe, German Chancellor Angela Merkel and French President Nicolas Sarkozy meet Friday, ahead of next week's European heads of state meeting.

"Markets are still eyeing Europe. We had a lot of rumors today of an Italy downgrade," Gilmore said.

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