Stocks set for smooth sailing in 2011

U.S. stock performance in 2010 can be roughly divided into three distinct segments: up, down, then up.

From the start of the year, equities climbed till late April, when the Greeks revealed they could not pay their bills, raising legitimate fears about the viability of the euro zone and survival of the euro currency. Then, stocks declined until early September, when it became abundantly clear that the European Union/International Monetary Fund would (with limits) pour money to save the weaker members of debt-strapped Europe and, more importantly, the Federal Reserve would spare no expense by pumping in hundreds of billions of dollars into the U.S. economy through the auspices of chairman Ben Bernanke's quantitative easing (QE) program.

Overall, despite all the twists and turns, and unexpected events (like the massive oil spill in the Gulf of Mexico by BP (NYSE: BP) and renewed tensions between North and South Korea), the major U.S. equity indices have racked up respectable gains of about 9 percent-10 percent this year.

Moreover, in the final weeks of the year, the Obama Administration agreed to extend Bush-era tax cuts -- an act which gave investors further optimism about a sustained economic recovery (offsetting fears of an ever-ballooning federal deficit).

Indeed, Wall Street appears to be almost universally bullish about U.S. stocks for 2011.

Goldman Sachs forecasts the S&P 500 index gaining more than 20 percent over the next twelve months, driven by improving corporate profits, strong balance sheets, modest inflation and low interest rates. Goldman also sees annual U.S. GDP growth climbing from 2.5 percent to 4 percent by the end of 2012.

The path of earnings growth has rarely been smoother,” Goldman gushed.

Barclays Capital, Bank of America/Merrill Lynch and Deutsche Bank are predicting gains ranging from 12 percent to 15 percent for the S&P 500 in 2011.

We are more optimistic than we have been at this time in each of the last two years, wrote Barclays Capital strategist Barry Knapp.

We are optimistic about U.S. corporate profits. Despite the downside risks, we believe monetary policy is likely to be supportive for equities in the first half of 2011 and perhaps for most of the year.”

Similarly, Larry Kantor, Barclay's managing director and head of research, forecasts that U.S. GDP will expand by an annual rate of 3.0 percent in 2011 and 3.5 percent in 2012.

Corporate balance sheets are strong, profitability is close to all time highs and valuations are generally below long term averages, said a report from ING. Not a bad picture at all.

Michael Yoshikami, president of YCMNet Advisors in Walnut Creek, Cal., is also bullish on U.S. stocks, forecasting a 13 percent gain [for the S&P 500 index] in 2011.

With the Fed pumping money into the system, and the tax cut extension taking effect, the recovery is already underway, he said.

These factors should propel stocks forward.

Goldman strategists recommend that investors increase their exposure to cyclical sectors, while continuing to favor technology, energy and financials.

The investment bank is particularly sanguine about large-cap banks, which they believe will benefit from improving loan demand. In fact, financials have been an undervalued sector this year, perhaps unfairly punished by the perceived turmoil among banks -- some analysts believe they are poised to outperform in 2011.

On the other side, Goldman suggests that investors scale back their positions in the defensive sectors like health care, consumer staples and utilities.

Knapp warned that major headwinds facing U.S. stocks in 2011 could come from continued deepening of the euro zone debt crisis

Their banking system is 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.

Other concerns include the rising federal deficit in the U.S. and monetary tightening in China, the world's factory and growth engine.

Yoshikami notes other risks to U.S. economic growth, namely continued high joblessness, and a potential further deterioration in the troubled real estate market.

The key question is, will investors respond to these lofty projections by returning en masse to the stock markets?

Understandably, many remain skittish about equities ever since the market plunge and near-implosion of the global financial system in 2008. U.S. stock funds have witnessed huge redemptions this year, while safer bond funds have enjoyed a bounty of money inflow.

Yoshikami is especially bullish on the technology industry, which is flush with cash.

Technology companies are a massive part of the S&P 500, he said.

The top nine tech companies account for over 13 percent of the S&P 500 index and include Intel (Nasdaq: INTC), Apple (Nasdaq: AAPL), Cisco (Nasdaq: CSCO), Oracle (Nasdaq: ORCL), Hewlett-Packard (NYSE: HPQ), Microsoft (Nasdaq: MSFT), IBM (NYSE: IBM), Qualcomm (Nasdaq: QCOM), and Google (Nasdaq: GOOG).

These companies alone have over $150 billion of cash available for investment, he noted. This cash hoard represents on average approximately 13 percent of their overall market cap.

With all that funding available, Yoshikami believes, tech will continue to expand its global empire, particularly in the fast-growing emerging markets.

The recent tech company acquisition trend is far from over. he noted.

Companies are turning more optimistic and are willing to invest in areas they believe will spur growth and capture market share.

There are two key structural forces that will continue to drive M&A activities in the tech sector, he indicated.

First, tech companies are moving quickly to increase both the scale and scope of their business, and become a one-stop shop for large-scale corporate IT buyers, he said.

Secondly, the increasing commoditization of hardware is forcing many tech companies to rapidly shift toward offering services as a significant driver of recurring revenue.

However, Abigail Doolittle, founder of Peak Theories Research, an on-line research firm in Albany, N.Y., expresses some caution about next year's outlook for U.S. equities. As a technical specialist, she explains that the market is either at or approaching a cusp or major inflection point whereby the stock market is poised to move up or downward quite significantly.

If the S&P 500 fails to break above a range made up of roughly 1,315, 1,325 and 1,335, we may be looking at a triple-digit S&P [below 1,000] and perhaps as low as 880, she said.

However, if the latter level of that range or 1,335 is cleared, it's quite likely we'll see the S&P much higher within two years and perhaps testing the index's all-time high of about 1,565 even though that level is unlikely to be sustained, again, based on the fundamentals.

On a fundamental basis, she adds, despite the government's tax cut compromise and the recent release of some modestly positive economic data, we’re sitting on an unsustainable mountain of debt, gradually shifting from private to the public sector. Can the public shoulder this burdensome debt?

She also cites a slew of pervasively negative fundamentals hanging over the market: high unemployment, the battered housing market, the seemingly endless euro zone crisis, and consumer spending that still has not rebounded to pre-crisis levels.

More ominously, Doolittle believes that the global economy will eventually enter into yet another crisis that will wreck havoc.

The first stage of the crisis was the subprime mortgage meltdown and collapse of Lehman Brothers, she said. The euro zone sovereign debt crisis is the second stage. Then, the third and final stage -- which has not occurred yet -- will make the first and second stages seem comparatively mild.

Doolittle declined to speculate on what the third stage would consist of, but she proposed that it may take the form of a “lender of last resort” crisis and be concentrated in the U.S.