European shares slip after rally, Telefonica drops

* FTSEurofirst 300 retreats from highs hit on Thursday

* Telefonica (Madrid: TEF.MC - news) falls after Q1 profits miss forecasts

* Prospect of new ECB stimulus keeps some traders bullish

By Tricia Wright

LONDON, May 9 (Reuters) - European shares retreated on Friday as a disappointing business update from leading telecoms group Telefonica sobered the mood after a rally the previous day.

The pan-European FTSEurofirst 300 index, which on Thursday hit a 2014 peak of 1,359.07 points that marked its highest level in around six years, was down 0.4 percent at 1,353.48 points by 1506 GMT.

Shares in Spain's Telefonica fell 2.7 percent after the company posted a 23 percent fall in first quarter net profits that missed market expectations.

Energy services group Petrofac (Frankfurt: A0HF9Y - news) slumped by 15.4 percent after it issued a profit warning.

Around two thirds of companies listed on the pan-European STOXX Europe 600 index have posted first-quarter updates so far, of which half have missed consensus earnings forecasts, according to Thomson Reuters StarMine data.

Some investors had been hoping for a strong earnings season to drive any further share price gains, with valuations now sitting at bloated levels after a bumper 2013.

"PEs (price/earnings ratios) can only expand for a certain amount of time until investors say okay, right, we need to see something delivered, and this earnings season ... has been a bit disappointing," James Butterfill, head of equity strategy at Coutts, said.

The STOXX Europe 600 trades on a 12-month forward PE of 14.1 times, against its 10-year average of 11.9 times, Thomson Reuters Datastream shows.

Christopher Mellor, equity strategist at London-based Sunrise Brokers, said these signs of weak corporate results were leading his firm to back an investment stance favouring bonds over equities.

"After 18 consecutive months of a pro-equity signal, our market timing model has now moved to a pro-bond stance," said Mellor.

Terry Torrison, managing director at Monaco-based McLaren Securities, expected European equity markets to drift before pushing higher in the second half of 2014, buoyed by expectations that the European Central Bank (ECB) could take new steps to support the region's economic recovery.

ECB President Mario Draghi said on Thursday the ECB was ready to take policy action next month if updated inflation forecasts merited such a move.

"In the short term we may drift, but I'm still bullish on the second half of this year. At some point, Draghi is going to come up with something," said Torrison.

Europe bourses in 2014: http://link.reuters.com/pap87v

Asset performance in 2014: http://link.reuters.com/gap87v

Today's European research round-up (Additional reporting by Sudip Kar-Gupta and Francesco Canepa; Editing by Janet Lawrence)