European stocks are likely to climb an additional 5% to 10% this year from current levels, boosted by double-digit profit growth, an executive with the fund arm of HSBC Holdings said on Monday.
European insurers and health care companies also offer some of the best potential upside for investors, while many consumer staple stocks have become pricey, said Anthony Eagleton, a European product specialist with HSBC's Halbis unit.
"We think the euro zone still presents a good investment opportunity. If you look down to the small-cap equities, you're seeing earnings growth which is emerging market-like," he told Reuters.
Paris-based Eagleton works closely with the team managing the 624.76 million euro ($864.1 million) HSBC Investments Euroland Equity fund.
HSBC said the fund returned 12.3% in the first half of the year, slightly lagging a rise in its benchmark, the MSCI EMU index. The index has since fallen back slightly and is up about 9.16% year-to-date.
Eagleton said a stronger economy and structural changes like wage restraint and improved productivity should fuel second-quarter profit growth of about 16% at euro zone companies.
At the same time, the firm expects price-earnings valuations on euro zone shares to at least hold steady at about 13 times 12-month forward earnings. The combination of rising profits and a steady valuation should take the market higher, he said.
"The market has been playing catch up to this profitability trend," he said.
The fund's largest holdings as of June 29 were German industrial conglomerate Siemens, Spanish bank Santander, and German health firm Fresenius Medical Care.
Halbis uses a bottom-up, stock-picking approach to its portfolios, rather than making top-down sector calls. But Eagleton noted the firm was currently overweight insurance and health care stocks on a sector basis, and slightly overweight energy.
"The insurance sector we find quite cheap. It's a sector that a lot of people don't know very much about, and so have been maybe concerned about exposure to subprime in their holdings. But we're quite positive on insurance," he said.
"We like health care because of the stability and cash flow. Right now all of the industries which have pretty high, visible cash flows we like."
Worries that problems in the U.S. subprime mortgage sector could sap U.S. growth have weighed on the dollar and other U.S. assets.
Other top 10 holdings at the end of June included Germany's Allianz, Europe's biggest insurer, drugmaker Sanofi-Aventis, Spanish blood products firm Grifols and Spanish oil firm Repsol.
The product specialist said the group is underweight shares of consumer staples companies, which are traditionally seen as a defensive play."
"It's a sector that we've felt has been pretty expensive," he said. "They've been trading at pretty high multiples. We prefer companies which have a higher level of growth right now."
Eagleton said the European team is overweight small-to-medium capitalisation firms in its portfolios relative to larger cap stocks because of its desire to own faster growing companies.