Are there reasons to be cheerful in Europe?

Well, here we are again; potentially another summer ruined by events in Europe. So laments Tom Becket, chief investment officer at Psigma, who admits that his faith in the ability of eurozone policymakers to tackle the region's economic malaise was misplaced.

Some pretty awful economic numbers have been testing investors' mettle, with confidence also battered by the ongoing conflict between Russia and Ukraine. That the big three economies of France, Germany and Italy posted negligible or negative growth in the second half of this year was not totally unexpected.

What has worried investors more is that the European Central Bank (ECB) seems unconcerned about tackling the emerging deflationary trend across the currency zone before it becomes entrenched.

Instead of printing money to buy assets via quantitative easing - which has given a short-term economic boost to China, the US, Japan and the UK - the ECB has preferred to pursue other routes to securing economic stability.

Is "whatever it takes" enough?

Essentially it still boils down to president Mario Draghi's proclamation of September 2012 that the bank would do "whatever it takes" to ensure the eurozone's economic stability, which boosted sentiment and sent European shares soaring.

Now there is a perception that "whatever it takes" isn't currently enough, and that has dented investors' confidence.

Rather than acknowledge fears of a fast-approaching deflationary juggernaut, the ECB points to arcane bond yield comparators that indicate deflation is merely a short-term problem. However, Jennifer McKeown, senior European economist at Capital Economics, reckons these comparators are misleading, because they reference only Germany and France, rather than the eurozone as a whole.

McKeown makes the point that during the ECB's monthly press conference in August, Draghi referred no less than seven times to the fact that long-term inflation expectations were "well-anchored" at 2%. This five-year inflation forecast compares with the current deflationary trend: the annual rise in the cost of living has fallen to just 0.4%.

She concludes that because there is so much spare economic capacity across the currency bloc today, firms and workers will not manage to push up prices or wages. "Deflation is a very real threat that the ECB should tackle sooner rather than later," she says.

Becket agrees, saying that Europe needs help before a Japan-style deflationary spiral across the region takes hold, something that has concerned Psigma for the past five years. "There's not enough growth and insufficient confidence, while the financial arteries remain clogged," he says.

Plenty would agree with his claim that "the architects in chief of this misery remain the distinctly useless cohort of politicians leading Europe through this period of decay". It leads Becket to conclude that there isn't any value in buying European stocks in this environment.

Silver lining

McKeown is among those eurozone watchers who do not think the ECB's plans to unclog the arteries and encourage banks to lend again will be enough to quash the deflationary spectre.

This €400 billion (£319.28 billion) targeted long-term refinancing operation begins in September and is expected to benefit the region's smaller and medium-sized businesses in particular. That is one reason to be cheerful. So is the fact that annual retail sales across the eurozone are up 2.4% and that manufacturing output is also firmly positive.

While acknowledging that the first half of the year has been disappointing, Francesco Conte, portfolio manager of JPMorgan European Smaller Companies Trust, is quietly excited.

"Our central case is that, whilst volatility is likely to continue in the short run, the second half of the year should provide evidence that Europe's recovery is gathering pace," he says. "This will be important for bolstering confidence that earnings can continue to grow. The ECB's stress test will be concluded, and we anticipate that this will remove some impediments to the flow of credit."

He adds that the ECB's recent lending survey was encouraging, showing that demand for credit is rising and credit standards are loosening. A weaker euro should also stimulate export demand as products and services become cheaper.

"We remain optimistic on the outlook for the rest of the year, though geopolitics are likely to dominate news flow in the short run," he concludes.

Despite a pervasive sense of unease about the eurozone's stability, investors should not forget the fact that, historically, European shares have been among the most rewarding long-term asset classes. With total returns of 145% over 10 years, they compare favourably against both UK and US equities.

Should the ECB keep Draghi's promise to do "whatever it takes" to keep the eurozone show on the road, the recent stockmarket weakness could be a buying opportunity.

And should financial markets also agree with McKeown's analysis, that the ECB will "implement quantitative easing around the turn of the year, as either inflation expectations fall or inflation itself remains dangerously low, regardless of expectations", share price momentum could start to build before then.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.