In a recent insight into US second-quarter earnings we wrote that “less worse is a good start”. The same could be said of Eurozone earnings. Looking at earnings and bottom-up earnings estimates, ie company by company, our CIO's equity strategists see the first signs of light at the end of the tunnel, with some stabilization at low levels.
Is it time to declare that Eurozone earnings growth has reached its tipping point? In our opinion, visibility is still too low for a definitive answer. Brexit has created uncertainty. Oil prices are still hovering around the 45 mark. The strength of the trade-weighted euro weighs on exports. And financial sector earnings are paying the price for negative rates.
To be sure that we have reached the tipping point, we need to see:
1) Confidence of consumers and companies consistently strong, mirrored by retail and auto sales.
2) Boost in oil prices and moderation in the appreciation of the euro trade-weighted, which would help the energy sector and export-oriented sectors.
3) Confidence in a return to revenue growth across all sectors, because the scope for further cost-cutting by companies appears limited. Revenue improvements could be critical to earnings growth. A pick-up in inflation would help not only by allowing companies to raise prices (at least in theory) but potentially by slightly increasing sovereign debt yields. Higher rates would help financials without hurting other sectors too much.
4) A halt in the deterioration of earnings in the financial sector. Diversified banking and financial stocks represent just over 10% of the Eurozone market. The steady decline in interest rates has led to a downward trend in loan margins and, together with subdued credit growth, has significantly dampened bank profitability. Market expectations on financial earnings for 2017 still appear too optimistic and need to be downsized before the recovery can begin.
5) A re-acceleration in the disbursement of credit which would indicate, and no less importantly, an increase in business investment and/or consumption. Stronger loan growth could help the Eurozone business cycle regain speed and boost earnings.
To determine whether Eurozone earnings are at the tipping point, we need to see more signs of a return to revenue growth, lower expectations for the financial sector and/or a renewed acceleration in credit growth to offset margins lower profits. Our bottom-up analysts also focus on movements in oil and the euro. At the moment however, we believe it is premature to change our neutral stance on Eurozone equities in global portfolios.
