Last week, we discussed politics in Europe and the implication of the elections on European governments. This week, we will take a look at the European equity earnings seasons.
With three fourths of companies having reported, we estimate that Q4 2016 earnings per share (EPS) growth was 9.3 per cent year-on-year for the Euro Stoxx 600, the index which includes eurozone, UK, Swiss and Scandinavian stocks. We have a positive outlook for pan-European earnings growth in the next 12 months, primarily supported by a weaker euro, higher commodity prices and stronger global growth. Despite a strong fourth-quarter rally, the current inflation and growth outlook for 2017 favours cyclical sectors over defensive ones.
Furthermore, financials, which make up over 20 per cent of European equity markets, are also showing progress. Higher bond yields in Europe and progress on Italian banking problems have eased the pressure on European banks. Higher bond yields around the world have helped boost earnings by supporting trading revenues as well as net interest margins.
Looking ahead, current forecasts for 2017 are for 14 per cent year-on-year growth in earnings per share (EPS), a significant improvement on -1 per cent year-on-year for the whole of 2016.
Upbeat forecasts can be explained by a range of factors, including:
Stronger global and domestic growth: Global Manufacturing Purchasing Managers’ Indices (PMIs) hit a multi-year high in January, implying global growth of 3-3.5 per cent in 2017. Eurozone PMIs are also at their highest levels since 2011.
Rising commodity prices: Consensus forecasts are for an oil price of US$60-65 by the end of 2017, supporting the energy sector’s earnings recovery.
Higher bond yields: Higher yields and a steeper yield curve help banking profits by boosting net interest margins.
Weaker currency: The Stoxx 600 sources approximately 45 per cent of its earnings from overseas. The euro is trading close to multi-year lows against the US dollar, providing an automatic boost to earnings.
Margin expansion: Increased inflationary pressure and improving economic conditions have pushed margin growth to its highest level in three years.
However, investors should be cautious about headline earnings estimates for 2017. Analyst forecasts typically start the year at overly optimistic levels before falling sharply over the next 12 months.
Let’s just look at last year as an example: forecasts for European earnings growth in 2016 began the year at 7 per cent before sliding as earnings growth failed to materialise.
We believe that the tailwinds are in place for decent European earnings growth in 2017; however, we would be more comfortable with estimates of mid to high single-digit earnings growth.
The valuation case for Europe
2016 was the worst year for European equity outflows since the financial crisis, as investors turned away from Europe and towards emerging markets and US equities. Even as macro data warmed up, flows cooled to negative levels. At the start of 2017, should investors consider allocating back to the region?
Global equity markets are not as cheap as they used to be. The S&P 500 is trading at a price-to-earnings ratio of 17.7x forward earnings, 11 per cent above its 25-year average. In this world of relatively expensive valuations, investors may want to look again at Europe. If we compare US to Europe, Europe looks cheap.
