Pessimism hits US, Europe outlook

An aggregation of expectations following the latest earnings season in the US and Europe points to an increase in pessimism among equity managers about prospects for corporate earnings ahead.



US fundamentals not overly solid – Jeff Rottinghaus, portfolio manager of the T. Rowe Price US Large Cap Equity Fund

We believe fears over a global recession are overdone, but it is clear we have entered a period of slow growth domestically in the US and internationally. From a bottom up perspective, we are somewhat cautious on the market currently; we do not anticipate seeing much earnings growth or free cash flow growth. Fundamentals currently are not looking overly solid.

It would not surprise us if the market traded sideways to down over the course of 2016. This is why we remain overweight in utilities and consumer staples. These sectors offer a degree of safety and also offer attractive capital return characteristics. The commodities sector remains in a tough spot, with an oversupply of oil and natural gas in the US.


Earnings face numerous headwinds – Robin Hepworth, manager of the EdenTree Amity International Fund

Given US equities currently trade at the top of their historical valuation range, we believe market upside going forward will be more closely linked to earnings growth, a dynamic facing numerous headwinds.

Strong sales growth should protect company margins from the negative effects of rising interest rates and rising labour costs. However, sales growth levels for US companies have clearly weakened over the last several months, primarily due to impact of a strong dollar and weaker levels of demand in international markets.

Companies have responded by reducing costs and succumbing to financial engineering. As a result, corporate profit margins stand close to record highs, lifted predominantly by labour cost containment, lower financing costs, elevated share buyback programmes and reduced effective tax rates. There is a risk that some of these tailwinds that have lifted corporate earnings in recent years may abate in the forthcoming years. A move higher in wage growth as the labour market tightens and rising interest rates as well as a strong dollar could all be significant threats to the corporate profitability of US companies and therefore minimise the upside for the US equity market.



Longest earnings decline since 2009 – Joseph Amato, president and chief investment officer – equities at Neuberger Berman

Earnings season was not necessarily great – the Q4 decline in US earnings marked the first time there had been three consecutive quarters of year-on-year declines since 2009 – but the soft spots in energy and banking were expected and there were few nasty surprises.

However, recent US manufacturing PMI was healthy, construction spending was up, consumers surprised on the upside, and the latest inflation and unemployment indicators looked favourable. Given the improved US economic outlook, markets are again pricing in higher probabilities of modest Fed rate hikes for 2016.


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So much pessimism on European prospects – Stuart Mitchell, manager of the SWMC European Fund

There is so much investor pessimism surrounding European equities, I have not witnessed this level of scepticism during my career. The reality tells a different story.

Excluding the miners and oil stocks, European earnings growth is expected to come in at 8-12% this year. Earnings have largely played out as we expected for our underlying holdings in recent quarters. We are continually seeing many positions delivering strong growth in excess of what the market was expecting – with companies such as Lloyds, Commerzbank and British Airways delivering strong numbers recently.

There is also a lot of negativity in expectations of European economic growth, so only the slightest uptick in growth would have an additional major positive impact on earnings on the Continent.


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Mismatch available in consumer discretionary – Tom Stubbe Olsen, manager of the Nordea 1 – European Value Fund

Analyst earnings estimates, which typically are too high at the beginning of the year, are being rapidly adjusted downwards already. We have emphasised earnings disappointments as one of the main risks we see this year.

Encouragingly, several consumer discretionary companies – notably LVMH and Swatch – have reported better figures than expected and said they do not recognise the negative picture being painted in the press about activity levels in China. Consumer discretionary is one of our largest sectors, and we see a significant mismatch between the underlying profitability of the business models and current valuation metrics.


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Wide variations between companies – Martin Todd, manager of the Hermes Sourcecap European Alpha Fund

While some European company earnings have disappointed, there has been a raft of companies still managing to beat estimates. Earnings have not been reflected in sector-wide trends but have varied from company to company – for example Lloyds’ upbeat earnings saw it get back on track, while Barclays slashed its 2016 dividend. From this evidence, it is clear the region has ripened for stock pickers.

For European exporters, China, the biggest global economic fear for many, is holding up strongly across a number of its industries, including luxury and consumer staples. This has been evidenced by better-than-expected earnings from companies such as Adidas. We are also seeing the potential for some M&A pick-up across a number of European sectors.

Furthermore, reliable barometers such as recruitment and auto car numbers have generally been good. These leading indicators support the case that Europe remains on course for a gradual recovery.

Jonathan Boyd
Editorial Director of Open Door Media Publishing Ltd, and Editor of InvestmentEurope. Jonathan has over two decades of media experience in Japan, Australia, Canada and the UK. Over the past 17 years he has been based in London writing about funds and investments. From editing the newsletter of the Swedish Chamber of Commerce in Japan in the 1990s he now focuses on Nordic markets for InvestmentEurope. Jonathan was awarded Editor of the Year at the Professional Publishers Association (PPA) Independent Publisher Awards 2017. Shortlisted for the same in 2016, he was also shortlisted in 2017 and 2015 for the broader PPA Awards category Editor of the Year (Business Media).

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