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Can Europe's markets climb through the slump?

Published on NewsOK Modified: January 13, 2013 at 11:25 am •  Published: January 13, 2013

Even after those recent gains, stock markets across Europe still appear cheap by standard measures. The typical company trades at less than 12 times its earnings over the next year and 6 times its cash flow. For U.S. companies, the same averages are 13 and 8.

To Kelly, there's a good reason European companies sell for a discount: The economic crisis is far from over. Europe's financial markets may look stable but the region's overall economy is shrinking. It's likely to keep shrinking, Kelly says, as long as European officials demand struggling countries cut spending on government services in exchange for aid.

"Austerity to fix a debt crisis doesn't work," Kelly says. "It only makes things worse. There's no evidence Europe's leaders really understand that."

So why do so many of Wall Street's investment strategists believe that European markets will keep climbing? Bank of America predicts Europe's economy will recover later this year and push stock markets up more than 10 percent. Morgan Stanley's London-based investment team says European stocks could rise as much as 13 percent and now favor Europe over the U.S.

One reason is that companies can thrive even when people at home curb their spending. Adidas and Bayer, for instance, lean more on customers in China and other countries with faster-growing economies than on customers in Bonn and Berlin. So analysts expect that as China picks up speed and the U.S. economy recovers, their sales will increase even if Europe remains stuck in a recession.

"China and other emerging markets are doing better," says Federated's Pazzanese. "That's great news to German and Italian exporters."

Another reason is that financial markets often heal before the underlying economy, says Martin Jansen, lead manager for international equities at ING Investment Management. Investors are supposed to be forward looking, if a little trigger happy. They ditch assets if the future suddenly looks bleak and buy them back again on signs, or hope, that things will eventually get better.

"Stability is one thing," Jansen says. "Getting back to normal is another."