* Cyclical stocks look expensive after rally
* Defensive sectors attract ETF money-Markit
* Healthcare among top earnings season performers
By Tricia Wright
LONDON, Feb 22 (Reuters) - European equity markets are starting to plateau and investors keen to milk further gains are switching into stocks better suited to a low growth environment.
Citigroup's keenly-watched U.S. Economic Surprise Indicator (CESI) has turned negative, a historical harbinger for outperformance of so-called defensive sectors such as healthcare and food and beverages, which are traditionally more reliable in terms of earnings and dividends.
The rally of around 24 percent seen in European equities over the eight months to a January peak, bolstered by the European Central Bank's promise to defend the euro, has left stocks that are highly geared to the economic cycle expensive.
The real estate and retail sectors, for example, are trading on 12-month forward price/earnings ratios of 18 times and 14 times respectively, compared with the market average of 12 times, according to Thomson Reuters data.
Meanwhile, deteriorating confidence in euro zone growth, political worries surrounding Spain and Italy and fears the U.S. Federal Reserve could prematurely wind down its asset purchase programme have seen stock markets drift back in past weeks.
Normally this might cause a rotation out of stocks altogether. But in a climate of low interest rates and below-inflation bond yields, equities retain the edge over other asset classes. So investors are turning to defensive stocks.
"We think that one should be looking over the next two-to-three months for consolidation in the markets ... (and for them) to have less of the cyclical weight and more of the defensive weight," JPMorgan analyst Mislav Matejka said.
JPMorgan recently moved its rating for cyclicals to "underweight" versus defensives, highlighting that during market pauses, pharmaceuticals and consumer staples tend to shine.
Its research shows that a move below zero on the CESI has, on the last five occasions, seen underperformance of European cyclicals against defensives during the following three months - by 4 percent on average.
Investors have started to shift that way this month, despite the already relatively expensive valuations.
Europe-focused exchange-traded funds covering defensive sectors saw net inflows of $39.2 million from Feb. 1-17, having suffered outflows in January, with the biggest boost coming from healthcare tracking products, according to data firm Markit.
Cyclical sectors, over the same period, saw net outflows of $186 million after attracting money in January.
"Before the economic situation starts to improve clearly in Europe, it will take time for the cyclicals to really do much better," Fabrice Theveneau, head of equity research at Societe Generale said.
Societe Generale is keen on pharmaceuticals, anticipating a modest rebound buoyed in part by their strong emerging market exposure.
True to form, at around half time in the European earnings season, defensives are among the top performers, led by healthcare.
In a sign this earnings superiority will continue, European healthcare and consumer staples sectors sit on implied 10-year EPS compound annual growth rates of 3.8 and 6.3, heralding better prospects of increased earnings against the STOXX Europe 600 on 2.4, Thomson Reuters data showed.
Citi European equity strategist Jonathan Stubbs described 'defensive growth', or firms with proven track records in times of broad economic and profit distress and which are growing faster than the market, as an "earnings call option".
A call option profile has 'limited' risk of falls but 'unlimited' potential for gains, and so defensive growth fits this billing.
Stubbs said that in 2008/2009, when market earnings halved from peak to trough, those for defensive growth firms fell less than 20 percent.
Citi is "overweight" healthcare, in which Sanofi, Bayer and Novartis are key picks, and food & beverages stocks, among which it likes Anheuser-Busch InBev and Danone.
"To chase cyclicals we'd need to believe in a strong pick-up in domestic or global growth - which we don't. Modest growth is unlikely to be the launch-pad for sustained cyclical outperformance in 2013," Stubbs said.