(MONEY Magazine) – With the expansion now 3 1/2 years old, the U.S. economy is clearly starting to chill out. Five successive interest-rate boosts by the Federal Reserve -- including August's half-point hike in the federal funds and discount rates to 4.75% and 4%, respectively -- seem to be cooling the economy. A July dip in factory orders and an August survey of purchasing managers document a manufacturing slowdown. The U.S. stock market is delighted with the resulting prospect: slow growth and low inflation as far as the eye can see. The Dow Jones industrial average jumped 4% in August and is likely to reach new highs above 4000 within the next 12 months. But across the Atlantic, most European economies are starting to warm up --and that makes stocks there even more promising than equities here. Exception: Great Britain, which started its economic recovery early and had its stock market rally in 1992 and 1993. Predicts William Wendler, a vice president of Rowe Price-Fleming, which manages the T. Rowe Price international stock funds: "We see gains of about 15% in Continental European markets in the next 12 months -- about double the outlook for U.S. stocks." So we too believe now is a good time to add stocks and funds to your portfolio that figure to profit from Europe's rebound -- until they equal 5% to 10% of your total holdings. Despite recent increases in Italy and Sweden, the major European interest- rate trend has been down. The pace-setting German Bundesbank has cut its short-term discount rate by 3.25 percentage points since 1993 to a recent 4.5% and is likely to make additional small cuts. As a result, most countries expect real economic growth of about 2.5% and rising corporate profits. Bouncing off recession-level earnings, large German companies appear to be headed for a 70% or so gain over 1993 while their French counterparts expect 40% growth, says Paul Brunkner, European economist at the Robert Fleming brokerage in London. So how can you profit? The most direct way is to buy European stocks sold here as American Depositary Receipts. Here are two: Ericsson Telephone (ticker symbol ERICY; OTC, recently trading at $54 a share; 1.1% yield), the $10 billion Swedish manufacturer of telecommunications equipment, is on track to increase its earnings 19% annually over the next five years with increasing sales of cellular-telephone equipment. Cowen & Co. analyst Marc Cabi sees a 12-month target price of $65. Daimler-Benz A.G. (DAI; New York Stock Exchange, $53; 0.9% yield), the $6.3 billion maker of Mercedes autos, has seen its European sales increase 25% in the first half of 1994 over the year-earlier period. Salomon Bros.' chief strategist in Frankfurt, Ralf Conen, believes Daimler earnings will rise by more than 50% in 1995. His target price within 12 months: $75. If you want to let professionals do the stock picking for you, consider a mutual fund that specializes in European shares. Two of the best: Vanguard International Equity Index Europe (no load; 800-662-7447) and Merrill Lynch EuroFund (4% load; 800-637-3863). Or you might investigate diversified international funds that recently showed a large portion of their assets invested in Europe. Two such, each with 10-year records that place them in the top 10% of all international funds: $4 billion Templeton Foreign (5.75% load; 39% in Europe; 800-292-9293) and T. Rowe Price International Stock (no load; 43% in Europe; 800-638-5660).

BOX:

ON THE ECONOMY "As the U.S. economy levels off at cruising altitude, major European recoveries are taking off."

ON STOCKS "We see gains of 15% for European stocks, about double the current outlook for U.S. equities."

ON BONDS "Prices of U.S. bonds will remain flat, as yields hold steady at around 7.5%."

CHART: NOT AVAILABLE CREDIT: Source: Prudential Securities MARK ROSENTHAL CAPTION: THE RECOVERY GETS INTO GEAR German industrial output, a bellwether for Europe's economies, is rising for the first time since 1992.