* Fund managers dismiss historical metrics in zero rates era
* Relative to bonds, equities still attractive despite risks
* Some investors wary of calling rally's end too early
By Lionel Laurent and Vikram Subhedar
LONDON, May 19 Investors are clinging to
Europe's white-knuckle stock-market boom, betting that the grim
economy, zero interest rates and stubbornly low inflation will
paradoxically keep driving equities to new multi-year highs.
European stock indices have held onto their lofty perches
despite the failure of the euro zone economy to grow as much as
expected in the first quarter, defying the repeated trimming of
analysts' 2014 earnings expectations.
Several investors said that with official interest rates and
bond yields still at rock-bottom levels, they were casting aside
doubts over nominal European equity valuations - currently at
their highest since 2004 on a price-to-earnings basis - and
betting more on the attractiveness of shares compared with the
unusually low returns on bonds.
The equity risk premium, which measures stock valuations
against the traditionally greater safety of bonds, suggests
there is still some juice left in the European equity market,
which currently trades bang in-line with its average historical
multiple of about 14 times.
"Even if the price-to-earnings ratio for European equities
hits 15 ... That may not be enough to stop the rally," said
Vincent Guenzi, portfolio manager at Cholet Dupont in Paris.
"Taking the risk premium into account, would it be so
shocking to even pay 20 times?"
There is some concern that equities, trading at decade-high
valuations, are vulnerable to a pullback given the cuts in
economic growth projections in the United States and Europe and
mounting risk aversion pushing down bond yields.
Analysts at Goldman Sachs say that equities grinding higher
even as bond yields drop is not necessarily incongruous.
Beneath the surface of broader indices, the underperformance
of some growth-sensitive sectors and the move back to defensives
shows that equities are pricing in some economic weakness,
Goldman analysts said in a note.
That sector rotation is keeping indexes up on the year.
There are other factors buoying stock markets: corporate
deal-making is supporting valuations and investors looking for
yield have latched on once again to dividends. Meanwhile,
relative to the United States, the valuation backdrop for
European shares appears benign.
A lot depends on how deeply investors are willing to delve
into history. On a 10-year time horizon, European stocks appear
pricey. On a 30-year horizon, however, they are still some way
from hitting the peaks of 23-24 times earnings seen at the
height of the dotcom boom in 2000.
Caught in a valuation no-man's land, investors insist that
the adjustment to the "new normal" of zero interest rates is
currently the key reason for riding out the equity rally, even
in the face of a slow-grind economic recovery and some analysts'
calls for a summer sell-off.
Traditional valuation metrics simply make little sense on
their own in the current environment without taking bond yields
into account, said Francois Chaulet, head of Paris-based asset
manager Montsegur Finance.
"What is the right price-to-earnings multiple? It's very
tough to say," said Chaulet.
"You may have a market that is priced at 15 times earnings
but if the benchmark interest rate is near zero...It would not
be a stretch to pay 17 or 18 times."
GREED AND FEAR
With no clear catalyst in sight to upset the valuation
apple-cart, fund managers are also mindful of the risk of
upsetting clients if they call a top to the market too soon.
"Fund managers are more worried about exiting a rally too
early than they are about exiting it too late," said Yannick
Naud, portfolio manager at Sturgeon Capital in London.
"Clients hate it far more when you miss out on a market rise
than when you are a victim of a market fall."
One shift in strategy within equities has been to skew more
towards low-risk, large-cap European stocks such as French oil
major Total or U.K. telecoms group Vodafone as
a way to stay invested while also seeking shelter from potential
Having seen off the worst of the euro debt crisis only two
years ago, investors say stock markets are still far from
erupting into the exuberance usually associated with market
"The markets are a story of greed and fear," said Cholet
"We have just exited fear - we're not yet into the greed."
(Reporting by Lionel Laurent and Vikram Subhedar; Editing by