* DAX second best performer in Q3 in Europe
* Favoured by more cautious investors returning to euro zone
* Cyclical weightings to benefit from global improvement
* Euro zone collapse, or crisis resolution pose risk
By Toni Vorobyova
LONDON, Oct 10 (Reuters) - German equities are proving to bemore than just a bolthole from the euro zone's debt storm andmuted company valuations and a cheap euro mean it should do wellunless the crisis deteriorates markedly or is fully resolved.
Exporters with a global reach, an economy that has stayedout of recession, and an abundance of solid household names madeGermany a top pick for those who wanted to - or had to - investin euro zone equities when the currency union's future looked inquestion earlier this year.
But the same characteristics are now attracting the morecautious investors who had stayed away from the region untilJuly, when European Central Bank President Mario Draghi said hewould do whatever it took to preserve the euro.
That helped Germany's DAX equity index gain 12.5percent in the third quarter - the second best showing in Europeafter volatile and risk-sensitive Greece . Comparativevaluations suggest that rise may have further to run.
"Clearly Germany is in better shape than everybody else. Ifyou want to buy a country that is not risky and is relativelycheap, Germany fits the bill," said Fabio Di Giansante, seniorportfolio manager for Pioneer Investments in Dublin, who managesaround 800 million euros and whose top picks in Germany includeAdidas and Continental .
Germany was also one of the places chosen by ABN AmroPrivate Banking, which manages 146 billion euros, when it turnedoverweight on European equities last month for the first timesince 2010, cheered by the ECB's policy actions.
The appeal of German equities is highlighted by Lipper data,which shows European-based funds with over $100 million inassets have on average raised their allocation to Germany to17.4 percent this year from 16.8 percent in 2011, whiledecreasing holdings of France, Greece, Portugal and Spain.
Germany's financial markets have benefitted almost acrossthe board from investors' need for a safe haven from the eurozone storm and a sagging global growth outlook that classicallydrives players out of stocks and into bonds and cash.
In such times, Germany is underpinned by solid statefinances and a relatively stable economy.
But its equity market also benefits from any sign the worldeconomy is improving since cyclical consumer goods and services,industrials and materials account for around 45 percent of theindex.
By comparison, the volatile financial sector has the biggestweight in the EuroSTOXX 50 .
"I am overweight Germany because valuation on the Germanmarket is pretty low and it will be probably the mainbeneficiary in Europe if you get global growth projectionsstarting to rise," said Kevin Lilley, European equities fundmanager at Old Mutual Asset Managers.
The DAX still looks cheap on some measures. For example, theindex, which is around 7,250 points, is trading at 10.4 timesthe earnings of its component companies, below the ratio's10-year average of 11.8 times, Thomson Reuters Datastream shows.
"By historical comparison, that is not an especiallyambitious valuation, so further price gains are quite possiblein coming months," M.M. Warburg & Co said in a strategy note.
"Even reaching and surpassing old DAX levels just above8,000 points cannot be ruled out from a valuation standpoint."
Germany's valuation looks particularly attractive if solidearnings expectations are taken into account.
Corporate profits are expected to grow 7.3 percent this yearaccording to Starmine SmartEstimates. By contrast, Spanishearnings are seen slumping by 45 percent but Spain's IBEX
has a higher price-to-earning ratio, of 11.1.
Meanwhile, a retreat in the euro, which has lost 4.5 percenton a trade-weighted basis from February peaks , has madeGerman exports cheaper for foreign buyers. It is a trend that isexpected to continue, according to a Reuters poll.
Exchange rates are one reason BNP Paribas strategists pickedGermany as their preferred investment region. They recommendlong bets on the DAX with short positions on the Russell indexof U.S. small caps or Japan's Nikkei .
RISKS ON BOTH SIDES
The DAX's strong export focus comes with a price, as wasseen in August 2011, when weak U.S. data sparked a slide thatsaw the index shed a fifth of its value in its worst monthlyshowing in nearly a decade.
Then, its safe haven appeal soon reasserted itself, and itoutperformed EuroSTOXX 50 in 10 of the subsequent 13 months.
But the global backdrop, in particular any sharp slowdown inChina, remains a risk, albeit one that could be partly offset bystrength in Germany's domestic economy.
There are also risks from euro zone developments.
A resolution of the immediate crisis that is sufficient toat least make investments in the likes of Spain or Italy morepalatable, could draw some of the most cautious investors, suchas foreign mutual funds, to pull some funds out of Germany.
"I wouldn't be surprised that as soon as they've taken uptheir weighting (in euro zone), that they will then take theirweighting out of Germany more in to the rest," said Andy Ash,head of sales at Monument Securities.
Conversely, despite its safe haven status, Germany cannotavoid being tainted if the euro zone crisis deterioratesmarkedly and concerns resurface about the future of the union.
It is Berlin who is largely funding the hundreds of billionsof euros already handed out in bailouts and if officialsultimately fail to rescue the euro, or later that could comehome to roost.
"I still see (Germany) as one of the more secure places inEurope but the main reason why people have been worried about(it) is that they are one of the few countries that are able tohelp out if problems develop in southern Europe," said PerKongsgaard, portfolio manager at Jyske Invest.
(Additional Reporting by Joel Dimmock, Editing by SwahaPattanaik and xxxx)
Keywords: EUROPE MARKETS STOCKS/GERMANY