After a turbulent few years for Europe, data seems to be pointing towards an improving economic outlook.

Crucially, in August the eurozone finally emerged from recession after 18 months, growing by a modest 0.3%

There is now growing optimism that a sustained recovery may be a genuine possibility.

According to the European Commission, annual GDP this year is forecast to contract 0.1% in the EU and 0.4% in the euro area. However, for 2014, economic activity is projected to expand by 1.4% in the EU and 1.2% in the euro area.

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In the past few days, fund group Schroders upgraded its European forecast on the back of strengthening momentum, improving consumer confidence and significantly stronger external performance which have all helped to lift activity across the economy.

While these figures may be the answer to many European politicians’ prayers, investors need to ask whether the positive data is sustainable.

An impending event is the German elections on 22 September. The general consensus is Angela Merkel will retain her position both as Chancellor of Germany and unofficial queen of Europe, albeit after being forced to form a coalition with the SDP or the Green party, or maybe even both.

Unlike other elections, investors seem to be less pre-occupied with this one and are continuing to pump money into European equities.

According to data from BlackRock, US investors pumped more money into European equities over the past six months than at any time since 1977 in a big vote of confidence for the region and its ability to break the shackles of the sovereign debt crisis.

In fact, there are now whispers of another ‘great rotation’ – this time from US into European equities.

Patrick Moonen, senior strategist at ING Investment Management, says: “It’s not clear whether a consistent positive relation exists between the average temperature on European beaches and market performance, but since the start of the summer global investors seem to look with a different eye to the European equity market. Although we must not get carried away – as one swallow does not make a spring – we think investors did rightfully become more positive on Europe.

“Earnings growth has troughed and we expect acceleration in the second half of the year and into 2014. Taken into account the high sensitivity of European earnings to even a small improvement in revenues, we expect margin expansion and double-digit earnings growth next year provided the global growth environment remains benign.”

Moonen says in valuation terms, Europe looks relatively cheap with the price/earnings ratio of European companies 15% below the global average.

 

He says: “Relative to the US market, the discount is even 35%, which is close to historic highs. Sure, Europe – or at least the eurozone – has some unique economic and political challenges in building a more stable monetary union, and these probably warrant a discount. But we doubt it should be as high as 35%.”

Although the picture in Europe is beginning to look brighter, it may be early days to say that it is completely out of the woods.

Investors keen to get European exposure need to take stock that the continent remains vulnerable to further shocks from the debt crisis.

There are rumours of yet another Greece bailout, and the economies of Spain and Italy continue to flounder, with high unemployment, little confidence and virtually no demand.

Paradoxically, a strengthening euro will also hit the continent hard. Most European economies rely heavily on exports, the German automobile industry for example, and a strong euro only spells trouble for those companies looking to sell to Asia and other markets.

However, for income-seeking investors Europe looks attractive.

Alexander Fitzalan Howard, co-manager of the JPMorgan European Income fund, says that Europe currently stands out as the region offering the highest dividend yield.

He says: “Of course, yields rise when prices fall, but the European market has recovered well since the financial crisis. Not only that, but there is scope for dividends to grow. Corporate balance sheets have been repaired, leverage is down to pre-crisis levels, and dividend cover is robust.”

While many are bullish on Europe’s chances of growth over the next few years, the consensus is that investors will need some heavy duty shock absorbers in place.

Douglas McNeill, investment director at Charles Stanley Direct, says the questions that plagued Europeans investors throughout the peak of the debt crisis ought to still be in the forefront over the next few months: “There may still be a eurozone break-up; it really can’t be ruled out. The wise investor doesn’t exclude anything.”

Investors should also take into account how the US Federal Reserve tapering off quantitative easing could hit European markets and that continuing geo-political problems in the Middle East will play havoc on global markets in general.

McNeill says investors who want exposure to Europe should invest directly in European companies rather than in UK companies that have substantial operations in Europe.

So, what should investors buy? Moonen believes there are three “promising themes”: further systemic risk reduction, more investment spending and a recovery in consumption. He says that the easiest way to get exposure to these themes is through financials, industrials and consumer discretionaries such as retailers.