It appears that the S&P 500 Index is set to finish 2010 at about 1,250, 12% above its reading of 1,115 on December 31, 2009. A survey of 11 strategists for big banks forecasts an average of 11% in 2011, with the estimate from Goldman Sachs Group, Inc. (NYSE: GS) forecast at 17%. The survey by Bloomberg News jibes well with another survey by The Wall Street Journal forecasting that GDP growth in the US will rise to 2.6% in the fourth quarter of 2010 and 3% in 2011.

The survey on GDP growth pointed out recent strength in retail sales, consumer sentiment, manufacturing, and foreign trade as reasons for optimism. The proposed tax bill negotiated between President Obama and Republican party legislators, which is expected to get Senate approval later today, is also an encouraging sign for equities. The proposed 2% cut to payroll taxes will put more cash in the pockets of the middle class, which is expected to spend the cash on more goods and services.

The proposed extension of the Bush-era tax cuts on those making more than $250,000 annually is likely the trigger for a rosier outlook on rising equities.

A strategist from Barclays plc (NYSE: BCS) told Bloomberg News, “I just think the outlook is favorable, so favorable that I struggle to see how the equity market doesn’t perform well.” That position seems to discount the effect of unemployment near 10%, with no special reason to see a large improvement in the number of Americans employed.

Rising equities, as measured by the S&P 500 Index, are, in fact, almost a lead-pipe cinch given the Federal Reserve’s QE2 program and the extension of the tax cuts for high earners. The Fed’s bond purchases are aimed at easing unemployment by adding as many as 700,000 jobs next year.

However, unless demand picks up, there is little reason to believe that companies will hire more people. That won’t matter for equities though, because richer Americans will still have those tax-cut dollars in their pockets and are quite likely to invest, rather than spend, it.

Goldman’s analyst quoted in the Bloomberg News survey noted that “company balance sheets have never been stronger” and that “S&P firms will increase spending in all categories, with the fastest growth in acquisitions and share repurchases.” That’s all good for shareholders, but not much help for employment. Acquisitions usually result in job losses, and share repurchases don’t do anything for the unemployed.

The economists surveyed by the WSJ see an unemployment rate of around 9% at the end of 2011, as the US economy adds just 160,000 jobs a month throughout the year. Home building and sales aren’t expected to do better than they have this year either.

The optimism for GDP growth centers on the expected effects of QE2 and the extended tax cuts. But unemployment could stifle growth in both GDP and equities. Still the predictions for growth in equities is in less danger simply because company profits should be better, helped by the higher unemployment numbers, or as the earnings reports call it, higher productivity. Sad, perhaps, but true nevertheless.

Paul Ausick

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