INVESTMENT FOCUS-Europe in driving seat as economic momentum diverges
LONDON, July 26 (Reuters) - Europe is beginning to grab the attention of investors who think its financial markets have most to gain from a turnaround in economic momentum which favours the developed rather than the emerging world.
Surprise improvements in leading indicators are prompting a rethink on Europe, which has long been dismissed as a laggard within the advanced markets, where the United States and Japan have led the outperformance over emerging markets.
Illustrating how Europe is gaining momentum, Citigroup's euro zone Economic Surprise Index - which has close correlation with equity markets - jumped to 40 on Friday, having spent much of the past three months in negative territory. Anything above zero indicates positive surprises relative to expectations.
In contrast, Japan's index looks to have peaked two weeks ago, the U.S. one is languishing below zero and the emerging market index is at -30. (http://link.reuters.com/rev89t)
With stock markets in Japan and the United States posting double-digit gains so far this year, investors may have squeezed as much juice as they can get out of a recovery story there.
Now they are looking for the euro zone and Britain to pick up the growth baton in the medium term.
"We see Europe and the UK as particularly attractive. These regions have been out of favour with international investors over the last 6-7 years and asset weights in these areas are still very low," said Nigel Bolton, BlackRock's head of European equities.
"From the economic point of view, the UK is looking in a better position and that will come through in terms of corporate earnings from domestically focused sectors. In continental Europe, which is 6-9 months behind the UK, we're seeing improving signs now."
Confidence in Europe is also driven by commitment from the European Central Bank, whose president Mario Draghi pledged exactly a year ago that the central bank would do whatever it takes to save the euro.
This week's purchasing managers' surveys (PMIs) showed unexpected growth in the euro zone's private sector for the first time in over a year in July. Other data also showed improvement in French industrial morale and higher Italian retail sales.
In contrast, Japan's export growth unexpectedly slowed in June, hit by a slowdown in China.
This comes at a time when many fund managers feel that the global economy has passed its growth peak, largely because of strong gains in U.S. and Japanese stocks this year.
Continental European stocks have risen 7.5 percent so far this year and the UK market 14 percent, behind U.S. and Japanese stocks.
Emerging markets have shown poor performance in general, with the benchmark index down 2.6 percent this year.
According to fund managers polled by Bank of America Merrill Lynch, 71 percent of them view the global economy as at a late cycle in maturity, nearing recession.
Against this backdrop, Europe stands to benefit from any positive surprises.
"As for European equities, we see the potential for an upgrade of our outlook in the second half of the year," Deutsche Asset & Wealth Management said in a note to clients.
"A look at the diverging earnings development in the United States and the euro zone since the beginning of the financial crisis reveals a considerable potential to catch up once the economy gains more traction."
Since early 2010, 12-month forward earnings per share in the MSCI U.S. equity index have risen 150 percent to 95, while EPS in the MSCI EMU + UK index have barely moved at around 10.
And Europe is likely to take time before it catches up with the other two regions with second-quarter corporate earnings coming in rather weak.
With 30 percent of STOXX companies having reported quarterly earnings, half of them beat or met forecasts. Analysts estimate companies earnings to contract by 5.4 percent in the quarter.
For S&P 500, 74 percent of reported companies beat or met targets and earnings are expected to grow by 3.9 percent.
Sixty percent of companies on the benchmark Nikkei index beat or met forecasts and earnings growth is a stellar 27.4 percent for this quarter.
"Our overall stance on European equities remains positive," said Jeffrey Taylor, Head of European Equities at Invesco Perpetual, saying cyclically depressed earnings are due to turn higher.
"PMI data is a generally timely indicator for the direction of economic growth in Europe and the trends are looking more helpful now."
(Editing by Ruth Pitchford)