By Natsuko Waki
LONDON, July 9 (Reuters) - Investors who have long dismissed Europe and Japan as laggards in any global economic recovery are starting to view equities in these regions as adequately priced for that underperformance and may look to put cash back in.
Convinced that the euro zone and Japan will find it more difficult than most to recover from one of the deepest global recessions of the past century, the stock market consensus is, for now, decidedly bearish.
A recent survey by Morgan Stanley shows just 19 percent of investors chose Europe as the best of 4 major equity market regions for the next year, versus 42 percent for the United States and 36 percent for emerging markets.
Japan -- where local stocks have been stuck in a broader bear market since late 1990s -- is the most unpopular region, the favourite market for a meagre 3 percent of respondents.
Fund managers polled by Banc of America Securities-Merrill Lynch have been picking Europe as the region they want to underweight the most on a 12-month horizon.
However, strategists reckon it may pay to bet against any big consensus positions on regional equity markets.
According to Morgan Stanley's data, areas that won more than 30 percent of votes for best region underperformed in 7 out of 8 cases, by on average 5 percent.
"We recommend closing any underweight positions in Europe. Valuation is attractive and at the bottom of the historical range on many measures ... while booming liquidity and recovering fund flows may also benefit non-U.S. markets," said Ronan Carr, strategist at Morgan Stanley.
"Japan may be the market with biggest potential to surprise on the upside... The contrarian today should favour Europe and Japan over the United States and emerging markets."
PAST PERFORMANCE
Pan-European stocks have fallen 1.2 percent so far this year, underperforming the 3 percent gain in MSCI's index of world stocks. Tokyo stocks are also way behind the global benchmark with a loss of 1.4 percent.
Currency shifts may have flattered those returns for unhedged overseas investors, but these markets have been far behind emerging economies and even come in shy of Wall St.
Mainstream economic forecasts may explain some of that.
The International Monetary Fund expects the euro zone -- where monetary and fiscal boosts to ease the recession fall short of those in the United States or Britain -- to contract 4.8 percent this year. That is almost twice the forecast 2.6 percent contraction for the United States.
Japan's economy, which never fully recovered from its own property-driven bust in the early 1990s, is expected to shrink a whopping 6.0 percent in 2009.
But looking into next year, the IMF expects Japanese growth of 1.7 percent, outstripping its forecast for the developed world as a whole by almost three-to-one.
The expected 0.3 percent contraction of the euro zone will continue to lag its major peers, but even there the gap next year is forecast to narrow slightly to less than one percent.
Valuations also argue for overweight position on Europe. Morgan Stanley's calculations show the MSCI Europe index trades almost at all-time lows on trailing price to earnings and price to dividend ratios.
On the bank's measure using indices such as price by volume and price/dividend, Europe is 35 percent cheaper than the United States, within the bottom decile of the almost 40-year range.
Clients polled by Credit Suisse said it might take a little more time for Japan to get ahead of its peers, with its analysis showing Japanese stock markets outperforming four months after the upturn in leading indicators.
"To most clients, Japan is just a later cycle cyclical play and into the downturn Japan had been hit more than other developed countries," the bank said in a note to clients.
Signs that increasingly risk-favouring U.S. investors have begun to return to overseas markets would also help Europe and Japan outperform in the medium term.
U.S. mutual funds increased their share of foreign assets to 24.5 percent in May, having kept it to around 23 percent since the beginning of the year, according to UBS.
This compares with a peak of 26 percent reached in mid-2008.
Within Europe, some like to focus on high-yielding stocks, where dividends are well covered by cashflow.
Tom Beevers, manager of the Newton Pan-European fund, likes Europe's largest entertainment group Vivendi, which yields 8.5 percent, and Europe's biggest telecoms group Deutsche Telekom, which yields 9.5 percent.
"It appears that the unprecedented fiscal and monetary stimulus is starting to gain traction, restoring a degree of confidence among consumers and corporates," he told clients.
(Editing by Ruth Pitchford)