FUND VIEW-State Street sees potential in European shares

* SSgA sees Europe shares to end higher in 2010

* Overweight pharma; modestly underweight financials

By Atul Prakash

LONDON, March 30 (Reuters) - European shares could rise further this year as valuations are still reasonable and the corporate sector is in good shape to benefit from economic recovery, State Street Global Advisors (SSgA) said.

Matthew Arnold, vice president at the Boston-based company, which manages $1.9 trillion, said stock market bears have been worried about the sustainability of the recovery and the likelihood of headwinds such as high unemployment and monetary tightening in the coming years.

"But earnings ultimately drive stock prices, and after taking out significant costs in the downturn, the corporate sector is well positioned to gain as the broader economy continues to pick up," said Arnold, who is also a senior product engineer at the European Active Equity team.

"Valuations, while not compelling, are also still reasonable. There are always risks around and things to get worried about, but on balance -- and given the alternative investment options such as cash and government bonds -- we think the market will be higher at year-end than it is today."

Arnold said that after returning to risky assets in the latter part of 2009, retail investors had continued to put money into corporate bonds and equities, though there seems to be a preference for emerging markets and Asia over Europe.

The early part of the rally since March 2009 was driven by a sharp recovery in stocks such as beaten-down cyclical and distressed banks, and the fund benefited from being overweight those types of companies, he said.

The SSgA Europe Alpha Fund rose 34.8 percent in 2009, against a 31.6 percent gain for the MSCI index. Its SSgA EMU Alpha Fund gained 31 percent, against a 27.3 percent rise for the MSCI EMU.

OVERWEIGHT PHARMA

Arnold said improving economic conditions also tend to lead investors towards more cyclical sectors, but he was overweight pharmaceuticals as their growth profile was solid and some companies looked very cheap.

According to Thomson Reuters data, the STOXX Europe 600 healthcare sector traded at 11 times its one-year forward earnings, against 21 times for automobiles and parts, 16 times both for food and beverages and technology and 15 times for chemicals.

Arnold said government incentive schemes around the world had stimulated demand for cars in 2009, but demand was falling as the schemes peter out. The fund is underweight autos.

"These stimulus programmes bring forward some purchases, but the underlying problem -- lack of demand due to an uncertain economy -- does not really go away," he added.

The retail and media sectors are cyclical and tend to perform well coming out of recessions, but old media firms are facing challenges due to competition from the Internet.

The fund is modestly underweight financials in aggregate, and prefers insurance sectors over banking and real estate.

"Insurance companies have benefited from the strong recovery in financial markets and generally speaking have less balance sheet issues than the banks," Arnold said.

"Some of the lower quality banks still face significant headwinds. The higher quality banks, in contrast, are in a much better position and are benefiting from reduced competition, extremely low short-term interest rates and more favourable capital market conditions." (Editing by Will Waterman)