Europe stocks play catch-up with US Wall Street may be getting all the attention as the S&P 500 hits successive record highs. Less noticed is that Europe is not far behind. Shares in Europe's biggest companies, swept up by the global risk rally and a pledge by the European Central Bank to do "whatever it takes" to save the euro, have reached pre-crisis highs. German stocks have set new records. The big difference between the US and European rallies is that the gains on Wall Street have been underpinned by improved earnings growth and evidence of a recovering economy. In Europe, by contrast, a dismal earnings season has set the tone for a disappointing financial year. Indeed, official output data this week showed eurozone growth in the first three months of the year declined for the sixth quarter in a row. The question on investors" minds is whether Europe could soon turn the corner, making the equities gains sustainable. "In Europe, the discrepancy between earnings and the market is the largest on record and so you need to have faith in the economic turnround," says Didier Duret, director of ABN Amro's private banking. This discrepancy is clearest in the consumer goods sector, where companies including Diageo, Unilever, Pernod Ricard and Nestlé are trading near record highs, even as their first-quarter results fell short of expectations. It is being driven by one factor: investors searching for income have shifted their focus to Europe. "The most important thing to have happened is not the re-rating of equity but the collapse of corporate bond yields," says Jonathan Stubbs equity strategist at Citi. Moves by central banks in the US, Japan and Europe to pump liquidity into the markets have pushed corporate and government bond yields to record lows, encouraging investors into higher-yielding riskier assets such as equities. Expectations that the ECB, after cutting interest rates this month, will loosen monetary policy further have prompted comparisons with action by the Bank of Japan and added fuel to Europe's rally. "With the very big commitment from Bank of Japan to reinflate the economy, Japanese equities have had a very big run: year-to-date they are up 42 per cent," says Barbara Reinhard, chief investment strategist at Credit Suisse Private Banking. The ECB also has a very big commitment, but the deleveraging process in Europe is in early innings. The bull case for European equities is that they are still cheap relative to historical averages, after being largely shunned since the eurozone debt crisis erupted in 2010. "While everyone takes the view that the rally has been purely liquidity-driven there are some fundamental criteria we can look at," says Gareth Evans, equity strategist at Deutsche Bank. Stocks across the Stoxx 600 index of European companies are trading at 13.4 times 2013 forward earnings, in line with historical averages. Companies in the industrial sector are particularly attractive, he says. AP Møller-Maersk, Siemens, Aggreko and Atlas Copco have become cheaper relative to the market and against their own historical valuations over the past three years. Banking stocks, unloved for much of the crisis, are another favourite for equity bulls, who say they are looking attractive as lenders shore up capital. Yet, so far, the rally has been underpinned by strong gains in defensive stocks with bond-like characteristics. Many investors remain cautious. Robert Farago, chief investment officer for Schroders Private Bank, warns that regional economic growth has not improved enough to make a bolder move into equities. "At the margin we've changed out of bond-like stocks into cyclicals but we don't see moving any further," says Mr Farago. There is value at the margin for cyclicals, because downside risks to the economy have decreased, but we are still in a slow-growth environment. Pictet Asset Management's investment team remains neutral on equities, questioning how much further the rally in Europe will go. "We will be surprised if the market is not going through a correction phase - if after a correction we see growth in China, there will be an opportunity to buy," Luca Paolini, Pictet's chief strategist, says. We are wary of joining the party when the fundamentals are weak. Fredrik Nerbrand, global head of asset allocation at HSBC, agrees. What is driving the rally is central bank policy that is pushing people to take increasing amounts of risks. I don't think this is warranted.