While earnings revisions continue to fall in Europe and stock valuations are drifting up, many analysts remain bullish, trusting that lead indicators like PMI will prove accurate and that strong growth is around the corner.

“Despite the improvement in the European economy over the last year, earnings revisions continue to be negative (we’re now into our fourth year of continual negative net earnings revisions) and have actually deteriorated further over the last week or so,” write Morgan Stanley analysts Graham Secker and Matthew Garman in an April 28 report. “The traditional lead indicators are telling a more positive story.”

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PMI and Morgan Stanley’s EGLI point to growth

While PMI is strongly correlated with earnings revisions, it’s far from a perfect signal – just a few years ago it pulled away from earnings revisions and hinted at a recovery that didn’t materialize, but this fits with the story that this is Europe’s year to pull out of the doldrums. Morgan Stanley’s EGLI model, which tracks EPS growth reasonably well, also points to a strong 2014.

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Secker and Garman recommend that investors remain overweight value stocks instead of growth, but that’s becoming more difficult in Europe as PE multiples rise and dispersion drops off. The five-year average for Eurozone stock valuations is still somewhat skewed by the financial crisis, but comparing to the last few decades only makes Eurozone stocks look moderately priced, still not cheap. At the same time, sector-neutral valuation dispersion is at the lowest point in five years and falling as people try to increase exposure to Europe at the lowest price possible, hoping for multiple expansion like US markets witnessed in 2013.

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EU periphery has lower valuations than the core

The EU periphery still has cheaper valuations than the rest of Europe, even though there are plenty of signs of a sustained recovery and smart money has been moving into the periphery for the better part of a year. Additionally, Graham and Secker recommend Eurozone financials because they have had better earnings revisions than the overall market and because they are less affected by a strong euro than cyclical sectors. And even if the European Central Bank decides to begin qualitative easing to bring the euro down, the financial sector will probably be the direct beneficiaries of a policy meant to indirectly boost the rest of the economy.

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