European economies are poised for a few years of only sluggish growth as stimulus measures subside and governments reduce massive fiscal deficits. A strong euro is also likely to put a damper on exports.

But according to money managers, even modest economic growth in 2010 could drive a strong rebound in corporate earnings and bolster equities markets. “There is still plenty of money to be made in European stock markets,” says Paul Casson, associate director of pan-European equities with London-based Henderson Global Investors Ltd. He is lead manager of Mackenzie Universal European Opportunities Fund, sponsored by Toronto-based Mackenzie Financial Corp.

Economic growth estimates for Europe this year range from 0.7% to 2%. But expectations for corporate profits in Europe are not so modest. Rory Flynn, global advi-sor with AGF International Advisors Co. Ltd. in Dublin, expects earnings growth of 10%-15%, and some money managers think earnings could increase by as much as 30%.

Casson points out that many European companies cut costs during the downturn, which will bolster their profitability in the next few quarters. “One dollar of revenue will be more profitable next year than it was this year, because the cost base is lower,” he says. “People could be positively surprised by how strong company earnings growth actually is.”

However, it’s critical that there be revenue growth. “The companies that can show us that they have a path toward growing revenues again will do well,” says Casson. “The ones that don’t will get punished.”

LOOK FOR GLOBAL FIRMS

That means it will be a stock-picking year. The markets will reward higher-quality businesses with good long-term growth prospects — such as utilities, consumer staples and health-care companies, says Matthew Benkendorf, vice president and portfolio manager with Vontobel Asset Management Inc. in New York, and lead manager of BMO Guardian European Fund Advisor Series, sponsored by Toronto-based GGOF Guardian Group of Funds Ltd. These sectors have continued to deliver earnings growth throughout the recession.

There isn’t much consensus on which sectors will do best. Some money managers like financial services or favour cyclical sectors that do well in recovery periods, such as consumer discretionary and materials. Others prefer defensive sectors that have consistent long-term growth, such as consumer staples, health care and utilities.

But one thing money managers agree on is that exporting companies with widespread international exposure -— as opposed to a focus on the U.S. market — should do well. Says Benkendorf: “The vast majority of businesses that we own are very global in nature.”

For example, the BMO fund holds British American Tobacco PLC, Imperial Tobacco Group PLC and Phillip Morris International Inc., whose revenues are generated from countries around the world, including emerging markets that offer substantial growth prospects.

Flynn agrees: “You look at a lot of other geographies, whether in Asia or Europe, and the consumer is in a better condition. I think it’s reasonable to assume that exports in Europe will be up next year.”

Flynn points to vaccine producers, such as Sanofi-Aventis Groupe in France, which could secure supply contracts for future pandemic situations as governments attempt to become better prepared for outbreaks.

Casson says exports from Europe have already begun to rebound, and he expects this to continue: “Demand is still healthy in other parts of the world for European goods, so I think that the export side will help us in 2010.” He likes Germany-based Fresenius SE, which specializes in dialysis equipment and has impressive market share in the U.S. He is also bullish on German car manufacturer Volkswagen AG, which “is absolutely everywhere, including significant exposure to Brazil, China and other emerging markets.”

THE EURO FACTOR

But European exporters face significant risks in 2010. Money managers point out that the strength of the euro against the U.S. dollar reduces the competitiveness of exports. “That’s negative for Europe overall, and particularly the big exporting economies such as Germany,” says Martin Fahey, head of European equities for I.G. International Management Ltd. in Dublin.

At an exchange rate around US$1.50, Fahey considers the euro to be 20% overvalued relative to the US$. And, he warns, the euro could continue to climb in 2010 as the US$ weakens further.

But others aren’t convinced that the euro will be that high. Indeed, quite a few money managers think the euro will soften as the US$ rallies on the back of higher than expected growth in the U.S. economy. (See page B12.)

@page_break@A key challenge for many European countries in 2010 will be record-high deficits. This problem is particularly acute in Greece, Ireland and Spain. These countries are facing pressure to reduce their deficits swiftly to the 3% level allowable by the European Union.

“This puts them in a bit of a weaker position than most other countries. I wouldn’t be getting excited about pure Spanish or Irish or Greek domestic consumption plays,” says Justin Nightingale, vice president of global equities at Natcan Investment Management Inc. in Montreal and manager of Altamira European Equity Fund, sponsored by Montreal-based National Bank of Canada.

Financial services sector woes also continue to present challenges for some countries. In particular, certain banks in Ireland, Belgium, the Netherlands and Britain continue to struggle with the negative impact of the crisis, Fahey says.

On the other hand, many fund managers see strong financial-sector investment opportunities. “Many financial companies will produce spectacular earnings growth,” says Flynn.

He particularly likes a number of smaller retail banks in Spain, France and Italy. They have repaid government loans and, as a result, are poised for a year that will be far stronger than 2009. IE