Money managers are forecasting a modest slowdown in the European economy in 2007, driven largely by lagging growth in the U.S. and expectations the European Central Bank will hike rates. Still, most experts agree that Europe is steadily shaking off its reputation as a slow-growth zone, and that low valuations present attractive investment opportunities.

“A lot of people haven’t paid attention to some of the things that have changed within many European companies in recent years, making them much more compelling investments than they once were,” says Greg Gigliotti, lead manager at Trilogy Global Advisors LLC in New York. “There are a number of regional opportunities in which you can invest around larger macroeconomic concerns and do quite well.”

Nevertheless, the rising euro, continued restructuring (particularly in Germany) and expectations of another 25- or 50-basis-point increase in interest rates are cause for caution. As a result, managers expect growth in the eurozone to slow to 1.5%-2% this year from 2.3% in 2006; Britain is expected to hold fairly steady at 2.5% growth.

Despite the slowdown, Gigliotti says, opportunities abound. Most analysts have been underestimating European earnings by about 3% each year since 2003, which has made pricing attractive.

“We’re just starting to see a lot of companies emerge from a very difficult period,” he says, “particularly industrials. They have clean balance sheets, free cash flows and most have paid down their debt.”

And European markets have managed to remove themselves from the influence of the U.S. dollar by increasing exports to emerging markets such as China and India.

But Gigliotti may be underestimating Europe’s dependence on the U.S. economy. Although it is true that Europe has diversified its trade to other markets, there are a significant number of European multinationals with a presence in the U.S., says Richard Kelly, an economist at TD Bank Financial Group in Toronto. In fact, Kelly says, 20% of Europe’s foreign direct investments are made in the U.S.

“So, not only is Europe going to feel the impact of the U.S. slowdown on trade,” he says, “it is also going to see a direct impact on the profitability of companies that have operations in the U.S., which will slow down with the U.S. economy.”

At the same time, says Kelly, a hot real estate market and growing mortgage lending may trigger the ECB to hike rates more than generally expected. The bank is keen on curbing money growth.

Germany’s 3% rise in its value-added tax begins this month, as well; it is widely believed this will push up wages and force the ECB to tighten further. “There’s still a great deal of restructuring to come,” says Kelly, pointing to Germany’s unemployment rate of almost 10%.

Europe’s restructuring woes do not deter Rajiv Jain, lead manager of GGOF European Equity Fund and managing director of Vontobel Asset Management Inc. in New York. Jain has found individual, predictable businesses that are selling at significant discounts.

“There are some fairly well-run, well-entrenched companies that operate globally,” he says. In addition, there are firms operating domestically that have managed to grow at a reasonably strong pace “without taking a lot of risk that one would take by going into other parts of the world.”

Jain runs a concentrated portfolio of about 36 names, which he typically holds for three to four years. His biggest weighting is in Britain (30%), although he is also finding significant opportunities in Switzerland (17%), Spain (15%) and Ireland (8%). He has not held anything in Germany for three years.

Jain is also getting emerging markets exposure through some of these holdings. His single biggest position is Tesco PLC, the largest grocery retailer in Britain with an almost 30% market share. Tesco also has operations in South Korea, Thailand and Turkey, and may expand into the U.S. in the near future. Jain also likes Imperial Tobacco Group PLC and British American Tobacco PLC. Both companies are reasonably valued at 13 times earnings and growing in the high double digits.

Rory Flynn, portfolio manager at Dublin-based AGF International Advisors Co. Ltd. , is heavily weighted in financial services, which account for 60% of AGF European Equity Class Fund. The sector has benefited from a flurry of mergers and acquisitions in recent years. Flynn has found value in French banks BNP Paribas and Société Générale, among others, that satisfy his high yield and low price/earnings ratio requirements.

@page_break@The fund’s 5% weighting in telecom includes France Telecom SA. Flynn says the company has fallen out of favour since the tech bubble burst but has an attractive P/E ratio of 10 and an impressive 4.8% dividend yield. France’s telecom regulator has been easing up on the company in recent months and steps are underway for full retail deregulation, which bodes well for the telco’s financial performance.

Flynn is significantly underweighted in pharmaceuticals, technology and oil and gas, which he feels are overvalued.

Gigliotti is finding value in Germany’s financial sector, including Commerzbank and HypoVerein Bank, both of which have high exposure to retail banking and real estate. As the unemployment rate drops, Germans are waking up to the idea of home ownership, he says. They are also taking their money out of low-yield savings accounts and pouring it into equity markets. At the same time, using less labour has helped buoy the German market, with companies becoming more competitive and, consequently, more profitable.

Risks to the outlook include rising unemployment, which would put a significant strain on retail banks, and a slowdown in the housing market as a result of higher interest rates. Kelly says Europe is tied to variable rates more than other areas, causing fluctuations to filter through the economy more quickly. But fast-growing countries such as Spain and Greece could even benefit from a deceleration.

A U.S. recession is another risk, but money managers say that’s highly unlikely. They assume U.S. growth will be a sluggish 2% this year. IE