* FTSEurofirst 300 up 0.3 percent; gains for fourth session
* Valuations, technicals positive
* Euro zone debt crisis keeps investors cautious
By Atul Prakash
LONDON, Dec 9 (Reuters) - European shares hit 26-month highs for a third day on Thursday on prospects that a proposed extension of U.S. tax cuts will help the world's largest economy.
Valuations remained favourable despite the recent rally in equities. The market also got support from an improving technical outlook, with stocks moving ahead in a broad trend channel after breaking a strong resistance level.
By 1230 GMT, the FTSEurofirst 300 index of top European shares was 0.3 percent higher at 1,123.27 points after earlier touching 1,127.67, the highest since September 2008.
The index is up 7 percent this year after surging 26 percent in 2009.
Financials were the top gainers, with the STOXX Europe 600 insurance index rising 1.9 percent and the banking index advancing 1.3 percent on expectations of an improving global macroeconomic outlook.
Bank of Ireland, Societe Generale and AXA rose 3.7 to 6.7 percent.
"From an asset allocation perspective, equities are the most compelling asset class now compared to most government bonds. Also, we have another big fiscal impulse in the U.S. which has brightened the near-term growth prospects for the U.S. economy," said Klaus Wiener, head of research at Generali Investments.
At the Reuters 2011 Investment Outlook Summit held in New York and London this week, leading investors indicated they wanted to avoid benchmark government bonds because their low yields were unsustainable.
Legg Mason Inc's Bill Miller, the star stock picker famous for beating the returns of the S&P 500 Index for 15 straight years and then crashing spectacularly in 2008, is bullish once again on stocks because of President Barack Obama's tax cut plan and the stimulus it will provide to the economy.
"Anything with good exposure to the U.S. is obviously going to have a huge benefit, especially on the consumer side," said Ben Critchley, sales trader at IG Index.
DEBT CRISIS LINGERS
But the euro zone debt problem kept a cap on gains. Fitch Ratings slashed Ireland's credit rating, saying the downgrade reflected the additional costs of restructuring and supporting the banking system.
Analysts said there was some nervousness, but they remained positive about the stock market's outlook.
"The euro zone credit crisis will linger, but it will not get worse. There is tremendous political risk but the market is fairly resilient," Wiener said.
Analysts said that despite a rally in equities, valuations were not stretched as the market has also witnessed a rise in earnings. They saw potential for the stocks to rise further.
European stocks look cheaper than U.S. equities. The STOXX Europe 600 carries a one-year forward price-to-earnings of 9.9 times versus the S&P 500's 12.7 times, according to Thomson Reuters Datastream. Macroeconomic conditions also remained favourable. The Bank of England's Monetary Policy Committee voted to keep interest rates unchanged and make no new quantitative easing purchases after its monthly meeting, in line with expectations.
Technology stocks gained, with Dutch chip equipment maker ASML jumping 5.8 percent after it raised its forecast for fourth-quarter bookings. A solid outlook by microchip maker Texas Instruments on Wednesday also helped shares.
Retailer HMV slumped 23 percent after it said severe weather was hitting Christmas trade, compounding problems caused by competition from grocers and the internet. (Additional reporting by Joanne Frearson; Editing by David Cowell)