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A Decade On, European Companies Are Still Looking for Profit Growth

European Companies Might Finally Deliver Profit Growth in 2020

(Bloomberg) -- Will this finally be the year European companies deliver profit growth?

It’s the question that’s been on investors’ lips for a long time. While earnings in the U.S. have steadily risen in the decade since the global financial crisis, European figures have stagnated. Time after time, bullish predictions have given away to a disappointing reality. Now, with equities already at a record high and monetary policy more likely to normalize than ease further, profit growth might be the key factor to make or break the rally.

Bottom-up analysts expect profits for Stoxx Europe 600 Index members to grow 8.2%, up from last year’s tepid 1% increase. That’s close to the 8.6% expansion expected for the U.S. However, many strategists are skeptical, calling the consensus too optimistic, and analysts typically tend to slash estimates as the year goes on, neither of which bodes well for a dramatic comeback.

A Decade On, European Companies Are Still Looking for Profit Growth

“With Europe on a relatively low valuation compared to the United States, investors can be more patient for earnings to develop as we continue into 2020,” said Edward Park, deputy chief investment officer at Brooks Macdonald Asset Management. “That said, for European equities to continue to rally from here we would need to see earnings come through.”

What could help is an economic recovery, with recent releases showing tentative signs of stabilization. While political crises in Europe have played a part in keeping investors at bay, the region has also been plagued with weak macro data and corresponding lack of earnings growth in recent years. Banks, once the heavyweights for profits, have seen their might dwindle amid a lower-for-longer rates environment.

So despite higher dividends and a near record-low valuation discount, the Stoxx 600 has underperformed the S&P 500 Index.

A Decade On, European Companies Are Still Looking for Profit Growth

Deutsche Bank AG strategists noted last month that European equities have lagged U.S. peers in the past eight years, after 40 years of keeping pace. Excluding the period around the European financial crisis and adjusting for the impact of U.S. corporate-tax cuts, they say earnings growth has been identical. Their baseline view, which assumes a pickup in European and global growth, is for the region’s earnings-per-share growth to match that of the U.S. in 2020.

Not everyone is as bullish. The reporting season, which kicked into full gear on Tuesday with UBS Group AG’s annual release, is likely to bring mixed results, according to Morgan Stanley strategists. They say consensus expectations for 2020 are “optimistic but not implausible,” and note that European equities have been increasingly resilient to earnings downgrades in the past year.

Goldman Sachs Group Inc. strategists led by Guillaume Jaisson say that analysts have been reluctant to slash earnings forecasts because of the stock market rally and cyclicals’ outperformance, which explains why fourth-quarter profit downgrades have been limited to just 1%. The current level of economic activity would suggest a 6% negative earnings revision, according to Goldman.

The Stoxx 600 surged 23% last year in its best performance in a decade, even as a Citigroup Inc. index shows profit downgrades have mostly outnumbered upgrades since May. The dissonance shows that equity gains were driven purely by an expansion in valuations, which presents a risk to further stock gains, according to Alain Bokobza, Societe Generale SA’s head of global asset allocation.

“We do not expect earnings growth to deliver any significant good news in 2020, under our assumption of a slowing global economy,” said Bokobza by email. “A valuation expansion process can’t continue forever.”

A Decade On, European Companies Are Still Looking for Profit Growth

While overall earnings growth has disappointed, digging deeper into sectors shows that most defensives have reported “solid growth” in recent years, according to Christian Stocker, a strategist at UniCredit SpA. The trend is likely to continue, he said.

Among European sectors, telecoms, technology, retail, utilities and oil firms are projected to show double-digit growth this year, according to Bloomberg data. The slowest pace of expansion -- less than 7% -- is seen in financials, basic resources and media companies.

Energy and mining sectors, which saw double-digit earnings contraction in 2019, remain vulnerable to weaker global manufacturing and commodity price swings, according to Brooks Macdonald’s Park. Oil has had a particularly volatile start to 2020 following the spike in U.S.-Iran tensions.

Forecasts are most bullish for tech earnings, even as a gauge tracking shares in the sector is near levels last seen in the dot-com bubble days. That’s driven by increased automation and corporate investments into the sector that will enhance margins, says Park.

Global Growth

For the exporter-heavy Stoxx 600, global growth and the strength of the euro will be key factors for corporate profits.

The single currency has been on the rise since September, when it reached its lowest since 2017, while the International Monetary Fund this week trimmed its outlook for world economic expansion to 3.3%. Although that’s slower than the 3.4% projected in October, it’s still the first pickup in three years.

The Stoxx Europe 600 advanced 0.2% on Wednesday following two days of declines. Gains were limited by declines in Italian banking stocks after the resignation of the leader of the anti-establishment Five Star Movement raised political risk.

“Europe is traditionally more cyclical and globally exposed in many ways, so if and when a firm global recovery develops, this side of the pond has room to step up,” said Tim Craighead, a European strategist at Bloomberg Intelligence.

--With assistance from Namitha Jagadeesh, Michael Msika and Jan-Patrick Barnert.

To contact the reporter on this story: Ksenia Galouchko in London at kgalouchko1@bloomberg.net

To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, Namitha Jagadeesh, Morwenna Coniam

©2020 Bloomberg L.P.