Sovereign debt woes have produced a seemingly endless stream of bad news out of Europe in the past year, but fund managers say the outlook for the continent is not all negative.

In fact, many fund managers expect economic growth in Europe to beat market expectations in 2011, which could bolster equities market returns. Fund managers are particularly confident about commodities, technology and sectors with exposure to emerging markets.

However, fund managers warn that 2011 will be a bumpy ride, with lots of volatility as sovereign debt problems continue to hamper confidence. Still, they believe corporations with strong fundamentals will be rewarded.

“We’ll see tension, we’ll see volatility,” says Simone Loke, vice president and director with Toronto-based TD Asset Management Inc. and lead manager of TD European Growth Fund. “But on the whole, it’s actually underpinned by strong corporate earnings and companies doing quite well.”

Adds Luc de la Durantaye, first vice president, asset allocation and currency management, with CIBC Global Asset Management Inc. and manager of CIBC European Equity Fund: “A number of economic fundamentals point toward Europe not being the basket case, necessarily, that is depicted by some of the media. I think the consensus might be surprised a little bit by the growth of the core European market.”

Although headlines have recently been dominated by news of huge fiscal debt loads, high unemployment rates and weak economic growth in peripheral countries such as Portugal, Ireland, Greece and Spain, these countries comprise less than 20% of the region’s gross domestic product. In contrast, prospects for core European countries — such as France, Germany, Switzerland and the Netherlands, which collectively contribute more than two-thirds of the region’s economic activity — are good.

“Europe as a whole is not necessarily weak, even though we’re seeing sovereign crises right now,” says Loke. “We’re still seeing relative growth in the whole region.”

The International Monetary Fund expects the eurozone to grow by 1.5% in 2011. But fund managers are considerably more optimistic, forecasting growth of more than 2%. They note that low interest rates have stimulated the region and depreciation of the euro has been highly supportive for export-heavy countries such as Germany — and they expect both rates and currency to remain low in the year ahead.

This economic expansion should help corporations grow their profits by an average of 10% in 2011, according to most fund managers’ estimates.

“You have the economy in pretty respectable condition, you have export markets generally in pretty respectable condition and you don’t have huge wage pressures,” says Rory Flynn, global advisor at Dublin-based AGF International Advisors Co. Ltd. and co-manager of AGF European Equity Class fund. He expects profitability growth to help European stock markets advance by 20%-30% in 2011.

Also fuelling this rebound will be inves-tors taking advantage of attractive valuations throughout European markets. Sovereign debt concerns have prompted many investors to flee from European equities, pushing valuations down to levels below those in Canada, the U.S. and many other countries.

“People have sold European markets [due to] the fear of contagion,” de la Durantaye says. “There’s a high risk premium that’s priced in in the current environment.”

Flynn sees attractive valuations throughout the continent, but particularly in Spain, which has come under scrutiny for its high fiscal debt. The concern is overblown, Flynn says, as its debt level remains manageable: “Spain really stands out as a place that has a lot more value than any other part of the planet. The Spanish economy isn’t the basket case that people seem to be worried about.”@page_break@Other fund managers, however, are staying away from equities in all of the so-called “PIIGS” countries — Portugal, Italy, Ireland, Greece and Spain — regardless of how attractive the valuations are. “We’re very underweighted in the peripherals,” says Loke, explaining that these markets continue to be highly volatile. “There will be a time when they become cheap enough, but I think we’ll wait for that for the time being.”

Instead, she’s overweighted in countries that will benefit from the weaker euro supporting stronger export activity, such as Germany, Sweden, the Netherlands, Switzerland and Britain.

“There’s a lot of misunderstanding in terms of Europe as a homogeneous area,” she says. “There are pockets where opportunities lie — and that’s how one should look at Europe; not as one country.”

Flynn finds that some of the best opportunities are in the financials and telecommunications sectors. He favours France Télécom SA and Spain-based Telefónica SA, which offer highly lucrative dividend yields.

Bank stocks throughout Europe have been punished by sovereign debt concerns, even though, as Flynn points out, they’re not all directly involved in the turmoil; the bank problems in Spain are in the smaller banks. Flynn sees particularly impressive value in France-based BNP Paribas and in Grupo Santander, a company that owns Spain’s largest bank, Banco Santander SA. Grupo Santander is a global bank that gets much of its revenue from Latin America.

Other fund managers, however, remain wary of banks as the credit problems continue. Loke has little or no bank holdings in the PIIGS countries, but is bullish on financials elsewhere, particularly those with exposure to emerging markets. She is partial to HSBC Holdings PLC, Standard Chartered PLC and Prudential PLC, all of which have extensive presence in Asia.

Many other sectors in Europe have ties to emerging markets such as China and India, and many fund managers are focused on tapping into those with the most exposure to these high-growth regions. Examples include energy and materials, industrial goods and consumer discretionary stocks. “We see opportunities in the oil and energy sector,” says de la Durantaye. “Oil prices will continue to be well supported, and we could start seeing shortages again.”

Loke agrees that raw materials’ prices will continue to rise on emerging markets’ demand. She is currently overweighted in materials, energy and industrial goods stocks. “Industrialization in the emerging markets is definitely benefiting Europe exports, especially in capital goods and industrial goods,” says Loke, who adds that capital goods companies will also benefit from increased domestic activity this year, as companies begin spending the hoards of cash on their balance sheets.

For this reason, she’s also bullish on technology stocks: “If companies want to improve their efficiency, they’ll want to increase [technology spending].”

Fund managers are divided on consumer discretionary stocks. Parus Shah, portfolio manager with Fidelity Investments in London and manager of Fidelity Europe Class fund, believes the sector will benefit from the rapidly growing middle class population in emerging markets. “Exporters are benefiting from demand from the emerging countries and also benefiting from demand from higher-end consumers, both in Europe and the U.S.,” says Shah, who especially recommends France-based luxury consumer-goods company PPR SA, which owns such brands as Gucci, Yves Saint Laurent and Puma.

Other fund managers are underweighted in consumer discretionary stocks, concerned that government austerity measures will undermine spending in 2011. Says Loke: “There’s a lot of cautiousness among consumers.”

Many fund managers are optimistic about the health-care sector’s prospects, particularly as the population ages. Shah likes Novo Nordisk A/S, a Denmark-based company focused on diabetes care. IE