UBS House View Weekly
Are earnings turning in Europe?
In a recent Deeper dive on US second-quarter earnings (4 August), we wrote “Less worse is a good start.” The same could be said for Eurozone earnings. Looking at bottom-up profits and earnings estimates, i.e. company by company, our CIO equity strategists see the first signs of light at the end of the tunnel, with some stabilization at low levels.
Is the time ripe to call the turning point of Eurozone earnings growth? In our view, visibility is too low to give a definite answer. Brexit has created uncertainty. Oil prices are fluctuating in the mid-40s. Strength in the trade-weighted euro is a headwind for exporters. And negative interest rates are taking their toll on financial sector earnings.
To call the inflection point, we need to see the following:
- Continued strong business and consumer confidence readings, as reflected in retail and auto sales.
- Oil price momentum and a moderation of trade-weighted euro appreciation, which would help the export-oriented and energy sectors.
- Confidence in the return of top-line growth across industries, as companies’ ability to cut costs further is limited. Improvements on the revenue side could be the decisive lever for earnings growth. A pick-up in inflation would help too by not only enabling companies to increase prices (at least in theory) but by potentially boosting sovereign bond yields slightly. Higher rates would aid the financials and do little harm to other sectors.
- A halt in the earnings deterioration of the financial sector. Banks and diversified financials account for slightly more than 10% of the Eurozone market. The continuous fall in interest rates has led to lending margins trending downward and, coupled with low credit growth, has significantly constrained bank profitability. Market expectations for financials’ 2017 earnings still look too optimistic and need to be lowered before recovery can begin.
- Reaccelerating credit growth, which would indicate, not least, an increase in corporate investment and/or consumer spending. Higher lending growth could help the Eurozone economic cycle regain speed, and boost earnings.
We need clarity on at least some of the above points to determine whether earnings are turning in Europe. Our regular meetings with companies should aid us in pinpointing the turning point when it comes. But we believe it is too early, for now, to shift our neutral Eurozone equities stance in global portfolios.
Global Chief Investment Officer
Head European Equity Sector Strategists
To determine the turning point of Eurozone earnings, we need to see more signs that top-line growth is returning, expectations for the financial sector are being reset lower and/or credit growth is reaccelerating to
compensate for lower profit margins. Our bottom-up analysts are also focusing on the oil price and euro movements. But for now we consider it too early to shift our neutral Eurozone equities stance in global portfolios.