European Domestic Earnings: From Survival To Revival by Philip Dicken, Columbia Threadneedle Investments
- European equity markets started the year in robust form, aided by a weak currency, low energy prices and quantitative easing (QE).
- Improvement in many eurozone economies supported strong earnings growth for many of the domestically focused stocks in Q2.
- We expect European domestic earnings to continue to be a strong contributor to the overall pick-up in corporate profitability in 2015 and into 2016.
European equity markets started strongly in 2015, aided by a number of contributing factors including a weaker euro, lower energy prices and QE from the European Central Bank. More recently, concerns over China have caused European and global equity markets to decline, and there has been a significant increase in volatility, but at the same this has exposed an attractive buying opportunity within Europe and improved valuation levels.
While a weaker euro tends to benefit the international exporters in our investment universe, lower oil prices and QE should help to stimulate the domestic economy in the eurozone – the domestic economy had been weak since the 2011 debut of the European sovereign debt crisis.
Improvement on the domestic front
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Signs that things are improving on the domestic front have been evident recently. QE has inflated the money supply, which in turn is stimulating domestic demand and business confidence. Furthermore, loan surveys suggest a greater supply and demand for credit in the eurozone. Retail sales have been robust and employment is now growing again.
Encouraging signs on domestic earnings too
On the earnings front, there have been encouraging signs. Europe overall has had a strong Q2 earnings season – the median stock has beaten EPS estimates by 2.9%, ahead of the 1.4% witnessed in Q1.
Within these numbers, euro-area companies have so far grown their earnings by 18% year on year, compared with a decline of 4.6% year on year for UK companies. Digging a little deeper, we find that a basket of domestically-focused stocks (constructed by Barclays) has beaten EPS estimates by a margin of 7.8%. These companies achieved 39% year-on-year earnings growth in Q2.
The trend in favor of stronger domestic earnings revisions versus the exporters is shown below.
Exhibit 1: Relative European earnings revisions – domestics versus exporters
Source: Barclays Research, Datastream, MSCI. August 2015.
A domestic recovery is helpful for Europe more generally
In order for European earnings to catch up with other developed markets such as the U.S. and the UK, we need to see a recovery of the domestic eurozone economy, and thus a recovery in the earnings of more domestically-focused equities.
We expect these underlying economic and earnings trends to persist, and for European domestic earnings to continue to be a strong contributor to the overall pick-up in European corporate profitability over the rest of 2015 and into 2016.
Also, it is important to remember that the European market offers attractive valuations. Bloomberg consensus shows the Pan-European market on a 2016E PE of 14.3x, yielding 3.9%. This appears undemanding if earnings continue to improve.