Strong earnings to boost European equities

"Company results are improving and markets will be able to shrug off the negative effects of high oil prices and interest rates," said asset manager Gert-Jan Geels at Eureffect in Amsterdam.

European earnings are growing by 10-15 percent on a pre-goodwill basis in 2004, putting the market on a prospective multiple of around 13 times, HSBC strategists said in a note.

"This looks to us to be inexpensive: we see fair value currently as a multiple of around 15 times," they said.

The markets' fixation on rising U.S. interest rates and security concerns, along with strong oil prices were overdone and an improvement in top-line earnings of European companies will override bearish sentiments, analysts said.

The FTSE 300 index .FTEU3 of pan-European blue chips hit a nearly 22-month high in April but the index is now up just five percent since the start of the year. Strategists expect a eight to ten percent rally from the current level of 1,006.

Mid-range forecasts in a Reuters poll issued earlier in June showed Germany's DAX index .GDAXI set to rise nearly four percent by the year end from Tuesday's level of 4,059 points. France's CAC-40 .FCHI is expected to advance five percent from Tuesday's level of 3,750 points.

Strategists said both markets have largely factored risks such as high oil prices and global interest rate hikes, and an improvement in demand is helping companies push up sales and cost-cutting is boosting profits.

The Federal Reserve is widely expected to begin a tightening U.S. monetary policy cycle and raise its key borrowing rate by 25 basis points on June 30.

Economists however expect no big increase in euro zone interest rates as inflation has proved unexpectedly tame across Europe.

SECTOR SELECTION

Sectors highly geared to an economic recovery such as technology and media top the shopping list of strategists while insurers are favoured on hopes of improvement in equity markets.

"There are lots of signs that global earnings growth has peaked. If that's the case, then there will be sector rotation and investors will go from growth to high-dividend stocks," said Jacob de Tusch-Lec, European equity strategist at Merrill Lynch.

The investment bank is overweight on technology and financials while being underweight on general industrials, basic materials, telecoms and pharmaceuticals.

Banks are also in favour.

"Banks are turning out good results and fairly generous dividends and are trading at low price to earnings ratios," said Nicholas Williams, a European fund manager at Singer & Friedlander Asset Management.

Oil and gas sectors have led the upwards revision in European earnings growth, accompanied by mining and metals, industrials and technology.

"What's keeping the markets at these levels is just geopolitical risk. There are some fears that earnings growth momentum will slow next year, but we feel those worries are overdone," said Gareth Evans, European equities strategist at ING Barings.