January 17, 2020 / 1:44 PM / a month ago

Europe Inc. eyes end to corporate recession in fourth-quarter

LONDON (Reuters) - Europe Inc. is likely to have turned the page on nine months of falling profits during the final quarter of 2019, but sky-high share price valuations and lofty earnings expectations for 2020 set a low bar for disappointment.

FILE PHOTO: The German stock market index DAX is reflected in a logo at the Frankfurt stock exchange in Frankfurt Germany, October 14, 2016. REUTERS/Kai Pfaffenbach

European equities rallied 24% last year as serial political storms, Brexit and the U.S.-China trade spat smothered economic activity but kept monetary policy super easy and borrowing rates at record lows.

But the scale of the price gains leaves investors wondering whether the earnings turnaround has already been priced in, leaving little fuel in the tank for a share price reaction to the Q4 profit updates over the coming weeks.

Meantime, European stocks hit fresh record high on Friday. Valuations for European shares are now roughly 15 times forward earnings, well above long-term averages but below the staggering 18 times benchmark crossed by their U.S. peers.

And while the relative comparison may still make Europe look somewhat attractive, many strategists fear the standing consensus forecast for 8.8% profit growth in Europe for 2020 is too optimistic and will eventually be scaled back.

“A lot of investors are sceptical about the potential for earnings to surprise meaningfully on the upside,” Barclays’ head of European equity strategy, Emmanuel Cau said, adding that it could be more of a “reality check”.

(Graphic: Europe 2020 earnings growth outlook - here)

After three-straight quarters of decline, STOXX 600 companies are expected to report profits growth of 2.5% in the fourth quarter according to data from I/B/E/S Refinitiv.

But that forecast has already more than halved from 5.5% in early November.

Pressure on British high street stocks is one case in point and they have plunged following Christmas sales updates, with Marks & Spencer’s describing conditions in clothing and homeware as “challenging” while Tesco said the market was subdued.

“There will be continued headwinds with traditional high street retailers. You need to own retailers that have an omni-channel approach, that have not only brick and mortar but also have a good online presence,” said Joseph Elegante, global and sustainable equities portfolio manager at UBS.

THE TRADE TRUCE EFFECT

The trade spat between the world’s top two economies dominated markets last year and ate into profits as companies grappled with supply chain disturbances and expensive imports.

With the Phase 1 trade deal sealed, investors could be drawn back to the bruised semiconductor and automobile sectors as inventories whittle down.

Pointing to improving manufacturing surveys, Elegante believes industrial companies are likely to come out of the woods this year.

Profits at European auto and auto component makers are expected to grow 10% in 2020, a solid reversal from a tumultuous 2019. UBS’s Elegante said he is modestly positive on the sector.

European semiconductor makers ASML and STMicro will report their results next week and investors will be closely looking for further evidence of turnaround in the sector after Taiwan’s TSMC reported strong results.

TSMC — a proxy for global tech demand given it has clients like Apple, Qualcomm and Huawei — forecast a sharp rise in first quarter sales on Thursday.

Semiconductor supplier ASM International also reported a blowout quarter triggering a massive rally in its shares.

“We are maintaining a little bit of a cyclical tilt to our portfolios,” Elegante said.

BON(D)ANZA

Investors will be paying close attention to numbers from BNP Paribas, Barclays and Deutsche Bank after U.S. rivals JPMorgan and Morgan Stanley’s fourth-quarter results raced past expectations on strong bond trading revenues.

Other European banks are also expected to do well with the financial sector expected to grow profits by 4.7% in the quarter.

For 2020, banks are expected to report profit growth of 3%, a marked improvement from an expected decline of 6% in 2019.

Swiss bank UBS, Dutch ING and Spain’s Bankinter report results next week.

Editing by Toby Chopra

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