Continental Europe was the top performing region in 2005, up 11.4% in Sterling terms. Europe has borne the brunt of the US Dollar’s slide and weakening global demand suggests its slowdown in 2005 may be worse than previously expected. Thus analyst’s optimism about European stocks may seem surprising.

The expected rate of growth in the €urozone is likely to remain modest (1.3% compared with 1.8% in 2004). However shares in European companies are attractively valued with price/earnings ratios around 14x compared with 16x globally. €uro interest rates should remain on hold but further currency strength could result in a (reluctant) rate cut by the ECB.

The €uro area profit cycle lags the USA by some months. So at present profits continue to grow and are expected to hold up well, despite the strength of the currency; these have been helped by frugal capital expenditure policies in the past. The area is more defensively priced than the US and offers eye-catching dividend yields. Companies also have the ‘advantage’ of fierce competition from neighbouring New European markets which has forced managers and unions to be pragmatic.

Provided consumer spending does not collapse, the growth picture in Europe will not change quickly. We maintain our 4% weighting.

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