European equities had their 42nd straight month of earnings downgrades in September, with an average of 100 downgrades per working day since March 2011, says a recent report from UBS. That’s not quite as bad as Japan’s 51-month downgrade streak in the early nineties, and fortunately there are signs that estimates could finally turn around.
“Bottom-up consensus earnings estimates have tended to be perennially too optimistic across many Global Equity markets. But even by these standards, the sheer persistence of downgrades in Europe over recent years has been dramatic,” write UBS strategists Nick Nelson and Karen Olney.
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Europe: Growth estimates turning around
After the global financial crisis tanked European stocks, there were nearly two years of earnings upgrades ahead of what people hoped would be an orderly recovery, only to get cut off by the Eurozone crisis. A relatively strong Euro has made recovery more difficult since then, though EUR/USD has finally fallen below 1.30 in recent months. Nelson and Olney argue that forex could go from being a drag on earnings to a driver if exchange rates go much lower.
They also note that September was the best, or least bad, month for downgrades in the last two years and that most of the disappointments have been in revenues instead of margins, so we could be at a turning point where analyst estimates start to turn around on average.
Banks account two-thirds of European growth estimates
Amazingly, 73% of consensus earnings growth is from the European banking sector, not something that most people would cite as a symbol of strength right now, but this is because non-recurring losses were so bad last year that stagnant loan growth without any other setbacks looks good in comparison. This also explains the big difference between 2014 consensus growth estimates with and without financials (5.6% and 1.3% respectively). Banking, energy, and capital goods account for 100% of 2014 consensus growth in Europe, with all other sectors netting out to zero.
But the poor news hasn’t necessarily kept investors down. Similar to how the US stock market re-rated in 2013 despite the tepid recovery, the MSCI Europe has re-rated from 9x to 14.5x in the last two years and is trending to get back above 2008 levels in the near future. Hopefully some economic growth will follow the prices up, though we may just be seeing another example of central bank-powered asset prices.