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(Stockbyte/Getty Images)
(Stockbyte/Getty Images)

Glimmer of hope for European stocks Add to ...

European stocks have rallied about 20 per cent over the past year, but the current round of optimism over the euro zone economy should deliver more.

Okay, “optimism” might be stretching things a bit. But FT Alphaville has an extensive roundup of recent reports that point to early signs of improvement. Indeed, they contend that the number of such reports has grown to “monsoon” levels from just a “trickle” earlier on.

For example, Goldman Sachs expects the euro zone to produce moderate growth by the end of the year “as the drag from weak domestic spending wanes and foreign demand growth picks up.”

That’s certainly upbeat, given that euro zone gross domestic product has contracted for six straight quarters.

As well, JPMorgan commented favourably on the success of the European Central Bank’s outright monetary transactions (OMT) program, a bond-purchasing program designed to heal rattled euro zone bond markets: “The OMT program has served as a powerful backstop for peripheral government bond markets.”

That puts JPMorgan on side with ECB president Mario Draghi, who recently said that the OMT program was “probably the most successful monetary-policy measure undertaken in recent time.”

All of which sounds great, but what does it mean for stocks?

European markets have been struggling for years with the overhanging debt crisis and ongoing recession. Since October, 2009, the MSCI Euro index has trended sideways in choppy action, meaning that it has delivered nothing to patient investors for nearly four long years at a time when U.S. stocks have been zooming higher.

Yet, things have improved a lot since last summer, with European stocks producing returns that are roughly in line with the S&P 500. This implies that the recent bout of optimism could be baked in already.

However, Europe still looks compelling. For one thing, professional money managers have not yet rushed in, implying that the region remains relatively undiscovered by the Big Money. A recent survey from Bank of America found that the greatest interest right now among the pros is in U.S. and Japanese stocks.

For another, the recent European equity gains put barely a dent in Europe’s long-term underperformance. While the S&P 500 has risen 150 per cent from its low during the financial crisis in 2009, European stocks have recovered just over 60 per cent.

And although the S&P 500 has been hitting a succession of record highs, the MSCI Euro index remains about 36 per cent below its high in 2007.

Besides underperformance and neglect, European stocks also have hefty dividends. The index yields 3.8 per cent versus just 2.1 per cent for the S&P 500 – essentially paying investors quite generously as they await market gains.

They might not have to wait too long. Apart from a slight improvement in the underlying economy, analysts are also upbeat about earnings. According to data from Bloomberg, analysts see euro zone earnings rising 29 per cent in 2013, which is well above expectations for just 9 per cent for the S&P 500.

Remember, Federal Reserve chairman Ben Bernanke’s comment in 2009 that the U.S. economic recovery was showing “green shoots” followed a 15-per-cent rebound in the S&P 500 – but didn’t signal the end of the bull market in U.S. stocks.

If what we’re seeing now is the euro zone version of green shoots, the gains have a lot further to go.

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