Market Watch

[Joemoney]

Economic Optimism Expected to Buoy Stocks

By Chelsea Emery

NEW YORK (Reuters) - Look for investors to dip their toes back into stocks in this holiday-shortened week as bets on an improving U.S. economy pull cash out of safe-haven pools of gold and bonds.

Don't look for any of that cash to come out of defense stocks, though, as Wall Street stays on guard for potential attacks following warnings from Vice President Dick Cheney that another strike is "almost certain," and as tensions in the Middle East remain white hot.

And while most fund managers expect low interest rates and resilient consumer spending to buoy stocks in coming weeks, lower-than-expected consumer confidence data or an attack could send investors scrambling for the shore again.

"I feel an upswell coming, but it's being camouflaged by warnings of another terrorist attack, bombings in the Middle East and India and Pakistan's nuclear capability," said Ned Riley, chief investment strategist for State Street Global Advisors, which oversees $60 billion. "But if we get through the weekend without significant events, the markets will pick up positive momentum."

The four-day week will bring scant corporate profit reports to guide Wall Street. Retailer Costco Wholesale Corp. (NasdaqNM:COST - News) is among the few companies scheduled to reveal quarterly results.

In the vacuum, investors will scrutinize a raft of economic data, including consumer confidence figures, expected on Tuesday, and productivity statistics, expected on Friday.

Confidence is key because two-thirds of the U.S. economy is propped up by consumer spending, while productivity is important because efficient companies can cut costs and improve earnings growth.

"Confidence numbers will be pretty good and I don't expect it to go down a lot," said James Luke, director of growth equity management at BB&T Asset Management, which oversees $10 billion. "I feel the market is poised to rally here, though I think we'll get away from explosive moves. It's a three-steps-forward, two-steps-back kind of market."

For the week, the Nasdaq composite index (NasdaqSC:^IXIC - News) fell 4.6 percent, erasing almost half of the previous week's rally.

The blue-chip Dow Jones industrial average (CBOT:^DJI - News) lost 2.4 percent and the broader Standard & Poor's 500 index (CBOE:^SPX - News) declined 2.1 percent.

Stock and bond markets will be closed on Monday for the Memorial Day holiday.

ATTACK WORRIES

Fears of more attacks similar to those on Sept. 11 cloud the outlook for stocks and have sent many fund managers pouring cash into defense and gold stocks. The American Stock Exchange defense index (AMEX:^DFII - News) is up about 22 percent this year, while AMEX Gold Bugs index (AMEX:^HUI - News) has more than doubled.

Investors are unlikely to pare these holdings any time soon amid continued turmoil in the Middle East and warnings that New York's landmark Brooklyn Bridge and Statue of Liberty may be targets of Muslim extremists.

Pakistan informed India on Friday it plans a series of missile tests this weekend, adding the tests are not linked to the military standoff on the border with its rival.

"There are terrorism concerns, war in the Mideast and tensions between India and Pakistan -- just name your hot spot," said Bruce Simon, chief investment officer at Glenmede Trust Co.

The firm has boosted its cash holdings in some funds to as much as 10 percent from an average of less than 5 percent in response to global tensions, Simon said.

But should more time pass without strikes in the United States, stocks should resume an upswing, fund managers and traders said.

That is, of course, unless economic data points to weakness in consumer spending or corporate productivity.

"Any substantial deterioration could spook the markets," said John Orrico, manager of the $11 million Arbitrage Fund. "But my sense is that they'll hold onto their (higher) trends and the markets won't be too disturbed."

Interest rates at 40-year lows and some improved profit reports from companies as diverse as doughnut chain Krispy Kreme Doughnuts Inc. (NYSE:KKD - News) and housewares retailer Williams-Sonoma Inc. (NYSE:WSM - News) have helped boost enthusiasm for stocks.

"You want to own stocks when the economy is improving," said Simon, who expects the S&P 500 to rise by mid-to high-single digits by the end of the year. "Absent terrorism fears, the market would be higher."

http://biz.yahoo.com/rb/020526/column_stocks_outlook_1.html