Barclays: The Long Awaited Recovery In European Earnings Is Finally Here

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According to a March 26th report from Barclays Equity Research, strong corporate earnings are likely to propel both European and Japanese equities to new highs over the next couple of quarters.

Barclays analyst Dennis Jose and colleagues note they are “raising our year-end targets for continental European and Japanese equities. Since the beginning of the year, both markets have risen by 19% and 12% respectively, bringing levels close to our previous targets. From current levels our new forecasts imply a further 13% of total returns for continental European markets, 9% for Japanese markets and 6% for global stock markets through to the end of 2015.”

Regarding Europe they note:

Our regional recommendations are driven by our optimism regarding the prospects for a recovery in earnings for both continental European and Japan corporates. In fact, for the first time since 2010, continental European stocks are receiving more upgrades than downgrades to their earnings forecasts. The long-awaited recovery in earnings for continental European equities finally seems to be coming through.

On a trailing basis, earnings growth for continental European equities is also back in positive territory, in line with the improvements seen in real GDP growth (Figure 11). Now our economists forecast real GDP to grow by 1.3% for the euro area in 2015 versus 0.9% in 2014. Pari passu this level of real GDP growth has historically seen earnings grow by c.10%.

However, this time round, we have also had a c.20% depreciation in the euro relative to the dollar which in the past has contributed to an equivalent increase in earnings growth for non-financial euro area companies (which was also noted by other analysts). A combination of these two factors, in addition to lower refinancing costs for corporates due to lower corporate bond yields, could lead to a dramatic increase in earnings growth rates for euro area non financial corporates.

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Earnings

Barclays is Overweight Europe and Japan

The Barclays report highlights that the firm is Overweight Continental Europe, Overweight Japan and Underweight the U.S. The long-awaited recovery in European earnings has finally materialized, and consensus analyst earnings revisions are positive for the first time since 2011. Jose et al. argue that that higher earnings will eventually lead to higher valuations.

Earnings

Japanese earnings revisions upward are also in high gear. Moreover, Japanese firms are also boosting shareholder payouts, and international participation in the rally thus far seems low.

U.S. earnings revisions are faring much worse. The analysts note: “We recommend an Underweight stance here, which, looking at fund flow data, still seems to be counter consensus.”

It’s all about earnings

Earnings

The report also highlights that they are overweight in areas where they see the best prospects for increased earnings. Barclays Global Recommended Portfolio is currently overweight in continental European equities by 10.1% and in Japanese stocks by 8.7% (relative to the MSCI All Country World Index) . On the other hand, the portfolio is underweight North American equities by 17.6% and neutral on emerging markets and the UK.

Jose and colleagues also note, that for the first time since 2010, European stocks are getting more earnings estimate upgrades than downgrades from analysts.

Earnings

Sector analysis

Finally, in terms of a sector analysis, the Barclays analysts prefer cyclicals to defensives. They note the gap between cyclical sectors and economic indicators has tightened up, but cyclicals still have some catching up to do. They are Overweight the Financials, Consumer Discretionary, Industrials, Materials and Technology sectors, but are Underweight Staples, Healthcare and Telecoms.

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