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Early trends show Europe is in an earnings recession

The consensus for Stoxx 600 earnings growth for the third quarter is around -2.8 per cent.

Oct 29, 2019, 09.28 AM IST
About a third of the way into the reporting season, the early trend seems to be confirming what bottom-up analysts had suspected: Europe has entered an earnings recession. While a majority of companies have been beating sharply-lowered estimates, indications are that profits are shrinking for a second straight quarter in absolute terms. Not that it's hurting markets — stocks have been climbing to fresh year-to-date peaks.

After slightly negative growth in the three months through June, earnings are pointing to another drop in the third quarter, according to strategists at Bank of America, Barclays and JPMorgan, which is in line with the poor macro backdrop, they say. The consensus for Stoxx 600 earnings growth for the third quarter is around -2.8 per cent.

However, Bloomberg Intelligence strategists Laurent Douillet and Tim Craighead write that early results actually offer signs of hope, as figures excluding the energy sector don't look too bad. Without the integrated major oils, they say third-quarter earnings growth for MSCI Europe companies is about 1 per cent.

It's even more dramatic for the UK, where they see a 6 per cent growth versus a drop of 7 per cent if Royal Dutch and BP are included. As the chart below shows, there is indeed a large dispersion between sectors, and defensives are faring much better.

Barclays strategists say the positive surprise is that earnings are not collapsing, even for cyclicals, with 58 per cent of European companies beating EPS estimates, and 63 per cent exceeding sales projections. Fullyear forecasts remain in a downtrend but should stabilize in the fourth quarter, they say. Still, as company guidance has been mixed, they find the 2020 consensus earnings estimates of double-digit EPS growth too high.

Given that the bar was lowered quite a bit before the season, investors may focus on outlook comments rather than rejoice over a third-quarter beat. Bank of America strategists don't see earnings inflection yet, and say revisions could stay in downgrade territory for longer. Currently, their model points to a 3 per cent drop in 12-month forward EPS, while consensus remains at 9 per cent growth for 2020.

Earnings growth may not be the main motivator for those buying stocks, however, given that the Stoxx 600 is trading near a 21-month high despite earnings being in the doldrums. BofA says the thirst for positive yield is key in helping equities beyond the weak cyclical data, while lower policy uncertainty can create internal rotations.

What happens if there’s no improvement in sight?

The question then is how expensive stocks can get before investors decide to look elsewhere to get bang for their buck.

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