Europe is facing headwinds in 2008 caused by a strong euro, inflationary pressures, slower growth in the economy and corporate earnings, and the global credit crunch.

But money managers say there are still plenty of undervalued stocks from which to choose. A decade of restructuring has invigorated the continent, which had been characterized by stagnant growth, bloated bureaucracies, uncompetitive labour laws, high corporate tax rates and high unemployment.

Finally, says Dana Love, lead manager of Toronto-based AIM Funds Management Inc. ’s Trimark Euro-plus Fund, European corporations are seeing the benefit of years of corporate restructuring, including outsourcing to emerging economies, which has helped push down labour costs. “You’ve almost had a renaissance in Europe, as far as corporate profitability and productivity is concerned,” says Love, who is bullish on Eu-rope generally.

Other positives include the introduction of common accounting standards, the expanding market as eastern European countries began to enter the EU and the advent of a single currency in 1999.

Today, Germany is the world’s largest exporter, in terms of economic value — despite the strong euro. “You can only imagine what growth in Germany might have been if it wasn’t impeded to a large extent by an extremely strong European currency,” Love says.

That said, the jury is still out on the extent to which Europe will be affected by the economic slowdown in the U.S. and the global credit crunch, in which European investment banks are directly involved.

One theory says that global growth has become decoupled from the U.S. economy, so that a recession in the U.S. will have less effect on other countries and regions than in the past. The question is: how valid is this theory in the case of Europe?

It may well depend on the severity of the U.S. slowdown. The more severe the downturn, the more other regions will be affected. And some bearish observers foresee the U.S. veering perilously close to an economic derailment, with no signs of recovery in its housing sector.

But even without a recession in the U.S., some economists believe no one will escape the impact of a downturn in the U.S. Many European multinational companies have operations in the U.S., leaving them vulnerable to a slowdown in consumer spending, which is expected to knock 1% off global growth — which will drop to 4.1% in 2008 from 5.1% in 2007 as other countries’ exports are hurt, says Richard Kelly, senior economist at TD Bank Financial Group in Toronto: “That’s providing a significant argument against these decoupling theories.”

According to Kelly’s forecast, real GDP growth in the 13-nation Eurozone — those that have adopted the euro as their currency — will be on the lower side of 1.5%-2% this year, vs slightly less than 3% in 2007. But, he notes, 2008 is shaping up to be a “tale of two halves.” The first half of the year will be fairly weak across the board, Kelly says, but things will pick up in the second half.

“We have a very low unemployment rate across Europe,” he says. “and that’s giving strong support to consumer spending. We should have a strong rebound.”

Europe is also grappling with inflation: food and energy prices, in particular, are rising. The inflation rate in the Eurozone rose to 3.1% in November from 2.6% in October, above the 2.5% target rate.

In an effort to quell this, the European Central Bank recently announced it would hold its interest rates steady at 4%, fearing a rate cut would add to inflationary pressures.

In the meantime, equity markets are sharply polarized, and money managers are on a shopping spree. Both growth and value managers like the financial services sector. Beyond that, growth managers have been shopping in sectors thought to be recessionproof, while value managers are scooping up deals in unloved consumer discretionary stocks.

Markus Koebler, manager of National Bank European Equity Fund, sponsored by Montreal-based National Bank of Canada, likes financials, which make up almost 21% of his portfolio, including the Greece-based EFG Eurobank Ergasias. He also owns shares in pharmaceutical company Novo Nordisk A/S, a world leader in insulin production.

But Koebler’s emphasis, as a growth manager, is on exposure to emerging markets and defensive sectors. “I want stuff that can grow in spite of the slowdown,” he says, and cites Telefonica SA, a Spanish telecommunications company that serves much of Latin America.

@page_break@Other examples include British Gas Group PLC, which, Koebler says, has a high rate of growth; and cosmetics firms Oriflame Cosmetics SA — which he dubs “the Avon of Europe” — and giant L’Oréal SA. He is also a fan of Reckitt Benckiser Group PLC, which he calls a “mini-Procter and Gamble”; and optical manufacturers Essilor International SA and Luxottica Group SPA.

Value managers take a different approach and sometimes have a much longer time horizon. For example, Rory Flynn, global advisor with Dublin-based AGF International Advisors Co. Ltd. and co-manager of AGF European Equity Class Fund, sponsored by Toronto-based AGF Funds Inc. , is stocking up on financials even though he thinks it could be years before the sectors’ stocks recover.

Flynn says there are some very attractive valuations and some “lovely” dividend yields to be had, noting that it’s not uncommon to find good stocks with dividend yields of 4%-7% that are trading at only seven to nine times earnings.

Flynn’s examples include Zurich Financial Services Group, as well as France-based BNP Paribas SA and Société Générale SA. He has also added to his position in pharma companies Sanofi-Aventis and GlaxoSmithKline PLC.

Love points to Anglo-Irish Bank Corp. PLC: while its stock price has been hurt by its exposure to U.S., British and Irish property markets, the bank has an old-fashioned lending style and is extremely picky when it extends loans. It has stayed clear of investment banking, conduits, derivatives trading and subprime lending.

Paul Casson, associate director of pan-European equities at London-based Henderson Global Investors, which manages Mackenzie Uni-versal European Opportunities Fund, sponsored by Toronto-based Mackenzie Financial Corp. , has recently increased his position in Royal Bank of Scotland. Like Flynn and Love, Casson believes the U.S. subprime woes have created some interesting investment opportunities: “RBS is one of the worst-performing bank stocks around.”

Casson also notes that although some major European investment banks were hit hard by the U.S. housing crisis, mainstream banks have fared better. He likes National Bank of Greece SA, a major holding that has been largely insulated from the liquidity meltdown and which appears to be a growth stock masquerading as a bank. “Whether it’s by luck or design,” he says, “it doesn’t have the exposure, so it doesn’t have the write-offs.”

Both Flynn and Love are steering clear of oil and gas services and certain other resources stocks. Love is also unenthusiastic about industrial commodities, some areas of technology and European utilities.

Casson, however, has some investments in Norwegian drilling and offshore oil services: “There are fantastic margins at the moment because there’s such a bottleneck of supply. If you have the assets when the market’s tight, you can charge what you want.”

Love is a fan of Bang & Olufsen
A/S, a Danish manufacturer of high-end audio equipment. He says it is an exceptional business whose stock price has suffered in anticipation of a slowdown in consumer spending. But Love thinks the company serves a niche market, and thus may be recessionproof.

Trimark Europlus Fund’s biggest holding, however, is the world’s largest food company, Nestlé Suisse SA, which in Love’s view has long been undervalued because of the company’s significant spending on restructuring and reinventing itself into a “health and wellness” company. Earnings and cash flow are accelerating as those actions begin to pay dividends.

Meanwhile, Flynn is shopping around in retail, even looking at housing-related retail stocks in Britain, such as Kingfisher PLC, a home-improvement retail group with operations in Europe and Asia. He says the company has had a “rough round” recently, but is nevertheless “a very solid company.” IE