European shares were ebbing further away from 14-month highs around midday on Tuesday, as doubts about the wider economy heightened valuation worries.

By 1027 GMT, the FTSEurofirst 300 had fallen 7.61 points, or 0.7 per cent, to 1,108.97, hurt by a survey showing German analyst and investor morale remained deep in negative territory in August.

Even though the ZEW measure broke a run of four monthly declines and beat the consensus forecast in a Reuters poll, the reminder of the loss of momentum in Europe's biggest economy undercut the optimism fuelled by central bank stimulus.

"The events over the past two weeks have helped reduce risk and the cost of financing, so it's improving part of the valuation equation," said Victor Peiro Pérez, head of strategy at Caja Madrid Bolsa. "On the other hand, we have a weakness in the flows companies are generating in the results, because the economy is weak in Europe and not very strong in the US."

He said further gains would depend on progress in shoring up Spanish banks and on third-quarter corporate earnings.

Banking and mining stocks have rerated to near post-credit crises highs of 11 and 12 times 12-month forward price-to-earnings, respectively, elevated by a combination of share price gains and poor earnings.

Mining stocks, having risen nearly 4 per cent over the last month, were weighed down by earnings concerns after Australia, the world's biggest exporter of iron ore, cut its revenue forecasts for the key steel making ingredient by a fifth on Tuesday.

The market-implied compound annual growth rate (CAGR) for mining firms is -4.6 per cent, compared with -2.6 per cent across all European companies, according to Thomson Reuters Starmine data.

FINANCIALS WEAK

Financials were weighing on equity markets too with banks, which gained about 9.5 per cent in the last month, joining insurers on the fallers list.

Aviva shed 4.5 per cent as Deutsche Bank and BofA Merrill Lynch cut their respective ratings on the UK-listed insurer on valuation grounds.

"Aviva looks fully valued... particularly so given a number of challenges in its UK and European life businesses in the coming 1-2 years," BofA ML said in a note.

Royal Bank of Scotland fell for a second consecutive session as Liberum cut its rating to "hold" from "buy", citing valuation concerns after Investec downgraded the taxpayer-supported bank on Monday.

Valuations concerns also knocked Swiss freight forwarder Kuehne & Nagel down 2.9 per cent as JP Morgan cut the firm to "neutral" from "overweight".

Renault shed 2.9 per cent, in tandem with other car makers, after a report showed European car sales fell 8.5 per cent in August, for an 11th straight monthly decline.

Tobacco stocks were the main gainers on European indexes, reversing recent underperformance as investors switch their focus back to fundamentals.

British American Tobacco (BAT), Imperial Tobacco and Swedish Match rose between 1.2 and 2.2 per cent as Nomura upped target prices across the sector, which has lagged the recent equity market rally.

With Europe's main indexes the German Dax and the FTSE 100 near 14-month and 6-month highs respectively, UBS recommended December 2012 calls on the FTSE 100 with a 6,000 strike and consider December 2012 put spread on the German DAX at 7,300/6,700 to offer protection against recent gains. – Reuters