Europe's riskier equity sectors may rebound in H2

LONDON (Reuters) - The underperformance of European cyclical shares from banks to car makers last month after a stellar start to 2012 is set to persist for most of this quarter, before a stronger economic outlook and company profits prompt a rebound, strategists say.

European banks .SX7P fell 8 percent last month alone, while technology stocks .SX8P lost 6.8 percent after strong first quarter gains.

In contrast, healthcare .SXDP, which underperformed the market from January to March, rose 2.3 percent as investors nursing multiple fears about the euro zone sought traditionally defensive sectors whose goods are in demand even in tough times.

"If you are looking at an investment horizon of four to six weeks, you could see a continued pro-defensive rotation. But we will be looking for confidence in global growth to recover in the second half, which could support cyclicals," Richard Taylor, head of international equity research at Jefferies, said.

Investors are concerned about the weak euro zone economy, the bloc's troubled debtors and the political uncertainties of elections from France to Greece.

But globally, economic data and company results point to a stabilising and improving outlook in the medium term. The U.S. manufacturing sector grew in April at its fastest rate in 10 months, while China's official purchasing managers' index hit a 13-month high.

In time, that should filter through to stronger demand for what European companies' products.

At home too, while underlying economic data remains weak, sentiment surveys such as the German Ifo are relatively upbeat. Most economists polled by Reuters still forecasting that the euro zone economy will return to growth in the third quarter.

Earnings in developed Europe are expected to beat the mean estimates of analysts by 0.3 percent in the second half of 2012, against a predicted miss of 0.9 percent in the current six month period, according to Thomson Reuters StarMine Smart Estimates.

GETTING WORSE BEFORE GETTING BETTER

In the near term, though, investors remain unsettled.

Francois Hollande, hot favourite to sweep French President Nicolas Sarkozy from office in Sunday's decisive runoff, has pledged to curb banks' "risky" trading activities, impose a tax on financial transactions and include growth measures in a German-inspired budget pact imposing austerity across Europe.

UBS client flow data up to mid-April showed investors racing back into defensive stocks at the fastest pace since September 2011. The healthcare sector was popular and client investment into the food and beverages was the largest in more than 15 months. On the other hand, selling in insurance shares was the biggest since January 2009.

"From here, we think things could still get worse, as hedge funds particularly reduce exposure and/or client flows prove elusive while we grind through some second quarter calendar risk such as the French election and the Greek election," UBS said.

The new politicians would need to demonstrate that they can still come to a consensus with their euro zone peers on how to stabilise the region before investors return to cyclicals.

Investors also want the European Central Bank to do more to stimulate growth, making sectors sensitive to the economic cycle become attractive.

"If we see a retreat of say 10 percent in stocks, you could expect another round of quantitative easing and that could prove to be a good environment to buy cyclicals. But without that support, it doesn't make much sense to invest in cyclicals," said Giuseppe-Guido Amato, strategist at German brokerage Lang & Schwarz, who retains a defensive bias for now.

(Reporting by Atul Prakash; Graphics by Scott Barber)