Stocks here may surge 70% by end-2016

Why you should be bullish on Europe
Why you should be bullish on Europe   

The European economy may appear mired in low growth and low-flation, but shares there are poised to surge as much as 70 percent by the end of 2016, Citigroup said.

"European equities offer investors a historic yield pick-up over both corporate and government bonds," the bank said in a note last week, adding that the region's stocks haven't been this cheap compared with credit for over 50 years.

Read More After Europe stock surge, can earnings follow?

"Share prices will respond, in the near- to medium-term, to a more general search for yield from investors," it said.

Low bond yields

Government bond yields across Europe have traded around record lows, with many short-to-mid dated bond yields turning negative in recent months. Those yields are likely to remain pressured as the European Central Bank (ECB) begins its bond-buying quantitative easing (QE) program in an effort to stimulate the euro zone economy.

"While interest rates are unlikely to remain at current historic lows forever, it is reasonably likely that interest rates over the next five years will, on average, remain low compared to the last couple of decades," the bank said.

Citigroup raised its end-2015 Stoxx 600 target to 450 from 400 and introduced and end-2016 target of 550, as a "grey-sky" scenario, compared with the index's close around 393 Monday. Its "blue-sky" scenario is for an around 70 percent upside by end-2016, or a target around 670, using higher growth and rating assumptions.

Read More Did the ECB quash the negative-yield trade?

For its grey-sky scenario, Citigroup expects 10-25 percent cumulative dividend growth, market payout ratios rising back toward their average levels and a dividend yield rerating to around 2.25-3 percent from around 3.1 percent currently.

Citigroup isn't alone in expecting the sun to shine on Europe.

"The euro is on its way lower, but European asset prices are on their way higher," Julius Baer said in a note last week. "Better-than-expected profits and increased capex plans from Carrefour, Aviva and Friends Life are tangible evidence that the European economy really did bottom late last year and is now recovering. That coupled with the ECB buying 60 billion euros a month in public sector securities starting next month until September next year, provide a decent tailwind for the region."

Stocks already rising

To be sure, Europe's stocks have already risen quite a bit -- with the Stoxx 600 index up nearly 15 percent so far this year amid strong inflows. Around $35.1 billion has flowed into developed Europe equity mutual funds and exchange-traded funds (ETFs) so far this year, according to data from Jefferies.

These factors will life European stocks
These factors will lift European stocks   

Fund managers' allocations to Europe have become the most crowded since mid-2007, according to Bank of America-Merrill Lynch's February fund manager survey, with a net 51 percent making the region their top pick and the "intention to own" euro zone stocks at the strongest level since the survey began in 2001.

"It is as if there is not a single bear left," the survey said in mid-February.

But Citigroup said it doesn't believe actual positioning reflects the consensus bullish view.

"Institutions, such as insurance and pension fund groups have tended to be significant net sellers of equity for many years," with little net equity demand from retail investors, Citigroup said. "Equity market net inflows have been dwarfed by those into fixed income over the last few years."

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1