By Lucy Raitano and Samuel Indyk
LONDON (Reuters) – European third-quarter earnings rose sharply from market lows and investors are bracing for better rhythms than in years, although weakness in China’s demand is a cause for caution.
Two months before the start of Europe’s earnings season, analysts cut their earnings growth estimates by nearly 380 points, data from LSEG I/B/E/S showed, giving companies a lower bar than expected.
Analysts often cut their growth forecasts just before earnings season begins, but usually by only about 100 bps.
So far this season, with about 50% of results reported, about 56% of companies have beaten expectations, according to Citi equity strategists, in line with the average quarter.
As the US heads to the polls on Tuesday, uncertainty from the election could keep European stock trading volatile for a while.
We look at five lessons from the leading Q3 European season so far.
LEADS ARE REWARDED
In previous reversals, companies that exceeded expectations were rewarded more by investors than those that missed forecasts were punished.
An analysis by Bank of America Global Research found that stocks that beat expectations beat the market by 1.8% on average on the day they announced earnings, the second strongest in a decade, while non-EPS companies underperformed by 0.8%, mostly in line with historical estimates.
“Concerns about Q3 earnings in Europe have increased ahead of the Q3 report,” said BofA equity strategist Andreas Bruckner.
“These concerns appear to be overblown, with earnings recording a positive surprise, reflecting: EPS-beating companies being well rewarded for outperformance; and Q3 EPS consensus revised up 3% in recent weeks.”
WEAKNESS OF CHINA BITS CYCLICALS
While stocks were largely rewarded, the impact of China’s flailing economy also played out amid volatile European stocks, with warnings of weak demand from the world’s second-largest economy cutting across sectors.
“The wage trends we’re seeing right now are bad everywhere, there’s a big wage revision and the range is down in every region, but it’s worse in Europe than elsewhere, some of it has been in China-related sectors like autos,” said Graham Secker, head of equities at Pictet Wealth Management.
Luxury bellwether LVMH, carmakers Mercedes-Benz (OTC: ) and Volkswagen (ETR: ) and energy company BP (NYSE: ) all warned sluggish activity in China weighed on results.
CHINA SIMULUS PROVIDES EXPLANATION HOPE
Despite the doom and gloom – and the real impact on Q3 figures – there is still hope for a recovery in Chinese demand given the stimulus measures announced in September by the Chinese authorities to bolster its economy, and the possibility of more to come.
Bernie Ahkong, CIO Global Multi-Strategy Alpha at hedge fund UBS O’Connor, said it is not surprising that companies are still bearish on near-term demand from China, but European stocks are responding very well to earnings. in finance and real vision.
“…investors are looking at these stimulus measures as a given, and we are seeing short covering and de-risking by hedge funds in the US election,” Ahkong said.
Some investors, on the other hand, say they want hard evidence that China’s stimulus is trickling down into the real economy and into company balance sheets.
BANKS RIDING THE INTEREST RATE WAVE
European banks had another good quarter, as still high interest rates supported margins.
The European Central Bank is expected to lower borrowing costs, yet investors remain optimistic.
“Interest rates will be structurally higher than they have been in previous cycles,” said Thomas McGarrity, director, head of equities at RBC Wealth Management.
“That’s very helpful for the banks. We’re not going back,” McGarrity said.
Data from LSEG I/B/E/S estimates financial income growth of 20.6% in the third quarter, the third highest growth rate among major European sectors after utilities and basic materials.
To date, their data shows that 80% of companies in the industry have beaten earnings expectations.
SPECTACULAR GROWTH VIEWS PROVIDE SMALL OPPORTUNITIES
Europe’s economy has been stagnant for nearly two years, hampered by a booming industrial sector suffering from rising energy costs and soft global demand.
Many of Europe’s biggest companies have a global presence, but weak domestic demand is affecting the wages of small and medium-sized people and the outlook remains fragile.
“We’ve had this downturn in corporate expectations and the view now is that the recovery will happen in 2025,” said Marlborough fund manager David Walton, whose strategy focuses on smaller companies.
“We are in a situation where it is not clear whether there will be a meaningful recovery in growth in 2025, but that creates an opportunity because we are able to buy companies at low prices.”
European companies remain historically cheap, trading at 13.6x 12-month forward earnings versus the long-term average of 14.3x. Mid-caps are even cheaper, trading at a trailing 12-month P/E of 12.7x versus a long-term average of 15x.
