Share prices reflect corporate profit prospects and earnings expectations so an end to a recession in real earnings across Europe bodes well for investors. The potential for a return of real growth could even come with the double-whammy of incrementally better profitability plus upward share price re-ratings as market sentiment improves.
As the S&P 500 takes a tumble and European stocks outperform the S&P 500 for the first time since the US election, there is a growing consensus that Europe’s earnings recession is over, reckon experts at JP Morgan Asset Management.
European stock market investors have been backing indices across the continent for a few months, fore-running the data and powering the Euro Stoxx 50 index beyond the performances of the S&P 500, or the FTSE 100 for that matter.
‘There are two important reasons to expect an end to the earnings recession,’ suggests Stephen Macklow-Smith, European equity fund manager and strategist at JP Morgan Asset Management. Firstly, he believes that in a synchronised global recovery both real growth and inflation are rising, meaning that nominal growth will be better than for many years.
‘The magic level for sales growth (which maps onto nominal growth) is around 2.5%,’ the fund manager spells out. ‘Below that level margins contract but above that margins expand, so this year should see better top line and better margins,’ Macklow-Smith believes.
‘The second reason is that there has been a rolling earnings recession across a variety of sectors, notably banks in the run-up to the stress tests, energy and commodities in the last two years because of falls in product prices.’ This accounts for any sector exposed to emerging markets given weak growth in the last three years (which itself was related to the decline in commodities prices).
‘This year those extraneous effects are absent so we have clean growth across a number of areas,’ he says.
The earnings recession in equities began in emerging markets (in local currency terms) in late 2013, sparked initially in Brazil and Russia. Other economies quickly followed and the earnings pinch seeped through into developed markets in February 2015, according to data points researched by analyst at investment bank Morgan Stanley.
Many investment experts and market watchers called the end of the earnings recession in the US in the third quarter of 2016. Now it could be Europe’s turn.
