Growth, valuation to keep Europe share rally alive

LONDON (Reuters) - European equities have a lot more ammunition to fire in 2010 even after an eight-month bull run to new highs, as improving economic data and impressive earnings in the third quarter tempt investors to grab risky assets.

A global economic recovery following the worst financial crisis since the Great Depression of the 1930s raises the risk of an earlier-than-expected withdrawal of trillions of dollars of stimulus packages by governments and central banks across the world, which could be a serious setback for the markets.

But most analysts say that such a situation could only arise after the first half of 2010 and until then European shares could enjoy an easy ride after already surging 60 percent since a lifetime low in early March to a 13-month high this week.

The FTSEurofirst 300 index .FTEU3 of top European shares is still down 37 percent from a multi-year peak in 2007, giving scope for further gains in the coming months, analysts said. On valuation grounds also, the market remains quite attractive.

"We think concerns about an impending end of the positive impulses are, however, premature and still consider the setback potential for the equity markets limited, also because the valuation has remained moderate," said Gerhard Schwarz, head of global equity strategy at UniCredit in Munich.

"A sustained increase in volatilities is still not in the cards. In fact, the apparently still very guarded sentiment continues to create scope for positive surprises, for example on the development of dividends," Schwarz said.

In terms of price-to-earnings ratio, shares in the DJ STOXX 600 .STOXX index trade at around 13 times one year forward earnings, against a 2004 peak of 14 times and a five-year average of 13.5 times, analysts said.

UniCredit is overweight insurance, technology and travel & leisure sectors, but underweight banks, food & beverages and retail.

Analysts said insurers looked cheap, but they remained skeptical on the ability of banks to keep rising after a 168 percent surge from March lows. The possibility of higher capital requirement of banks could also put pressure on the sector.

"We remain confident and positive," said Anko Beldsnijder, managing director of MainFirst Asset Management. "We have a feeling that investors are still underweight equities. Demand for equities will drive prices higher."

IMPROVING DATA, EARNINGS

The optimism also emanated from an improved economic picture, with industrial output rebounding and GDP growth coming back into positive territory in many countries, analyst said.

The Blue Chip Economic Indicators newsletter for November found forecasters had raised their 2010 projections for U.S. GDP for a fourth straight month. It said the economy should expand 2.7 percent next year, marking an upward revision from the 2.5 percent pace expected a month ago.

Latest figures showed British manufacturing output rose faster than expected in September, and at its fastest monthly pace since July 2002, rebounding from August's sharp drop.

"Companies have adapted very well to a lower demand environment and they are leaner and meaner now. If we go through a period of economic growth, that should put them in a strong position," said Henk Potts, strategist at Barclays Wealth.

Investor morale also got a boost from third-quarter earnings. The ratio of positive to negative surprises for the Standard & Poor's 500 .SPX companies in the third quarter will be the best in 15 years, analysts said.

Of 240 companies in the DJ STOXX 600 .STOXX index that have reported results so far, 57 percent posted earnings above analyst expectations, 1 percent in line and 42 percent reported earnings below forecasts. On aggregate, companies have registered earnings that are 2.6 percent above estimates.

"Now we are in a situation where pricing power for the corporate sector is gradually restored as we see the pressure from the inventory cycle is abating," Schwarz of UniCredit said.

HOW LONG STIMULUS TO STAY?

The July-September period has also seen revenue growth -- in contrast to the second quarter that was mainly about cost cutting -- raising expectations that the companies will see further topline growth in the next quarters.

"Markets are extremely happy about this quarter. It's not only about the bottom line, it's also about the top line," said Philippe Gijsels, strategist at BNP Paribas Fortis in Brussels.

"But you know that behind these earnings, there is an abnormal situation and the main question is what will happen when all the stimulus is taken off eventually," Gijsels added.

Sectors such as banking, automobile and homebuilding across the world received trillions of dollars of government support to stay afloat during the crisis -- stimulus which has to be withdrawn sooner or later.

"Central banks will only change their stance if they see a clear improvement in unemployment numbers, but that's still some way off, especially in the United States," said Luc Van Hecka, chief economist at KBC Securities.

(Editing by Jon Loades-Carter)