It wasnÆt stories about the inflation of pork prices in China that caught the attention of the portfolio managers and analysts at Credit Agricole Asset Management, which is now overweighting agriculture stocks in many of its regional equity portfolios. It was the disappearance of EuropeÆs own agricultural surpluses.

The European UnionÆs wasteful Common Agriculture Policy is infamous for subsidies to farmers that generated ôlakes of wine and mountains of butterö. For two decades, one reform after another has struggled to come to grips with these surpluses. ôBut itÆs taken less than one year to realise we now have a deficit of production in Europe,ö says StTphane Mauppin-Higashino, head of product specialists for equities and global balanced funds at CAAM in Paris.

He notes the price of milk in France has risen by 20%-30% over the past year, thanks to skyrocketing commodities prices. ôEventually what you see in Asia [regarding food inflation] will play out in Europe. This is a global phenomenon,ö he says. ôAnd itÆs not a one-off event but something that will last.ö

As a fund management company, CAAMÆs investment teams are looking to go as far upstream in agricultural production as possible, to seek out ôpure playsö. Although Mauppin-Higashino represents the European equities team, he says this is a global effort, one in which CAAMÆs Americas and Asia teams have agreed to seek out-performance from this sector in their respective regions.

The trick, of course, is to find stocks at the right price. Mauppin-Higashino says the firmÆs investment teams are keen on areas such as grain manufacturers and companies making heavy equipment such as harvesters. Although opportunities are global, he expects the European equities team to fare particularly well.

Prices in European equities are at historic lows, he argues, with the market outside the United Kingdom trading at an average P/E of 11x expected earnings growth. CAAM believes the market has been unfairly punished by the subprime crisis. The marketÆs fear of credit downgrades is too pessimistic, which has led to share prices that discount earnings growth expectations by minus 25%-30%; CAAM reckons earnings growth in 2008 will instead range between +5% to -10%, which is a big range but nothing like the discounts currently being applied.

ôWeÆve seen in the past segments of the market lost earnings growth by 30%, like tech in 2000,ö Mauppin-Higashino says. ôBut weÆve never seen this happen market-wide.ö

With deep pessimism plunging European shares to very low levels, he reckons this will attract strategic institutional investors (including sovereign wealth funds) and encourage corporate M&A activity. Active portfolio managers can find sectors that are most likely to outperform low expectations.

CAAM likes big cap over small cap, and insurance companies versus banks (which have been indiscriminately punished by the subprime crisis). But at a global level the big bet is on agriculture, and in particular, European plays, where agriculture stocks trade within the same range of valuations as the broader market, and where their stock prices have yet to converge with very expensive contracts on commodity futures.