Europe Priced for No Profit Growth Signals Stocks Rally
European stocks are trading at levels that show investors anticipate no profit growth for 2013, increasing optimism among strategists who say equities will rise to a five-year high.
The Stoxx Europe 600 Index (SXXP) is priced at 11 times estimated profit, down from 13 before the financial crisis, according to data compiled by Bloomberg. Even though the region entered a recession last quarter, earnings will climb almost 5 percent next year, according to the average of seven strategist forecasts in a Bloomberg survey. They predict the benchmark gauge will gain 10 percent to the highest level since 2008.
While bears say 25 percent unemployment in Spain and Greece and austerity from France to Italy make expectations for any earnings growth unrealistic, Graham Bishop at Exane BNP Paribas says valuations 10 percent below historic levels show investors are too pessimistic. Stocks are the cheapest on record compared with bonds after European Central Bank efforts to stimulate the region’s economy, presenting opportunities to buy companies from Royal Dutch Shell Plc (RDSA) to Madrid-based discounter DIA, according to Macquarie Group Ltd.’s Daniel McCormack.
“There is room for further revaluation of euro-zone equities,” Nadege Dufosse, who helps oversee about $100 billion as senior asset manager at Dexia Asset Management in Luxembourg, said in a Nov. 20 phone interview. “Fundamentals are not good and will not change in the near term, but what we can expect is that the riskiness embedded in European equities will continue to decrease.”
Finance chiefs from the 17 euro-region nations met today for the third time this month to attempt to clear an aid payment to Greece and forge a blueprint for keeping the country a solvent member of the currency bloc. The talks come days after a European Union summit broke up without agreement on a proposed seven-year budget.
Optimism that policy makers will approve more funds for Greece helped push the Stoxx 600 to its biggest rally of the year last week. The index jumped 4 percent to 273.33 as U.S. President Barack Obama also expressed confidence he will reach a deal with Congress to avert $607 billion of automatic tax increases and spending cuts. The gauge slipped 0.5 percent at the close of trading today.
Strategists underestimated this year’s rally. The Stoxx 600 has climbed 12 percent, better than the 9.4 percent projected in a December 2011 Bloomberg survey, after the ECB announced a plan to tackle rising sovereign borrowing costs by purchasing bonds of countries that seek assistance. The index advanced 8.6 percent in 2010 and lost 11 percent last year.
The increase in 2013 would add about 700 billion euros ($908 billion) to share values in the Stoxx 600, the highest annual increase since 1.5 trillion euros was restored in 2009, according to data compiled by Bloomberg.
At the same time, valuations are so low that they imply investors expect income to stagnate. Based on the Stoxx 600’s level now, European profits would have to stay unchanged in 2013 for the price earnings-ratio to expand to the pre-crisis level of 13, the data show.
“Embedded in current European equity valuations is an additional risk premium which we believe is largely due to the current euro-area crisis,” said Gareth Evans, a strategist at Deutsche Bank AG in London whose prediction for a 23 percent increase in the Stoxx 600 is the most bullish in the survey. “If these risks were removed, this premium would be unlocked and the market would re-rate.”
The Stoxx 600 will rise to 301.5 at the end of 2013, the highest level since June 2008, based on the average strategist estimate in the Bloomberg survey. After a 0.5 percent contraction this year, the euro-area economy will grow 0.1 percent in 2013 and 1.2 percent in 2014, economists’ forecasts compiled by Bloomberg show.
Strategists, who base predictions on an analysis of the economy’s effect on earnings, forecast a third straight year of profit growth below 10 percent for companies in the Stoxx 600. The projection trails Bloomberg’s compilation of more than 12,000 estimates from equity analysts on the outlook for individual companies, which shows European profits will expand 9.3 percent. Between 2004 and 2006, income increased at an average annual rate of 26 percent, Bloomberg data show.
European stocks have risen this year even as analysts trimmed predictions for 2012 earnings growth to less than 1 percent from 14 percent, Bloomberg data show. The forecast income of 25.04 euros a share for the Stoxx 600 would still be 11 percent below the 2007 record, the data show.
Profits in the Standard & Poor’s 500 Index (SPX) will advance 6 percent in 2013 to a record $107 a share, according to the median estimate from 13 strategists surveyed by Bloomberg.
“The market is priced for a worse outcome than either we or the consensus believe will materialize,” Exane’s Bishop said in a Nov. 21 phone interview. He expects earnings will grow 9.4 percent in 2013, led by banks and mining companies.
The euro area still faces obstacles to solving its fiscal crisis, which forced Greece, Ireland, Portugal and Spain to accept European Union-led bailouts after their borrowing costs surged to euro-era records. The Stoxx 600 is 32 percent below its June 2007 peak, wiping out 2.5 trillion euros of market value, data compiled by Bloomberg show. In the U.S., the S&P 500 has climbed to within 10 percent of its all-time high.
European finance ministers last week failed to agree on a debt-reduction package for Greece as officials faced the tasks of pumping money to the recession-wracked country while taming the increase in its borrowings. Spanish Prime Minister Mariano Rajoy is resisting pressure to seek a second bailout that would allow the ECB to buy the nation’s debt.
Italian Prime Minister Mario Monti has pushed through 20 billion euros of austerity measures and overhauls of the pension system and the labor market. In France, President Francois Hollande plans to raise the two highest value-added tax rates.
The budget cuts are taking their toll. The 17-nation euro area contracted 0.1 percent in the third quarter, entering a recession for the second time in four years. The outlook for a worsening economy and political instability will weigh on stocks, said Societe Generale SA’s Paul Jackson, whose prediction for a 1.7 percent gain in European equities next year is the smallest of the strategists surveyed.
He said stocks will probably decline in the early months of 2013, before climbing toward the end of the year.
“The long-term sustainability of Greek debt is far from guaranteed and solutions are not forthcoming,” the strategist said in a Nov. 21 phone interview. “If the market comes down as we think it will, we would switch to a more bullish view.”
The Stoxx 600 traded at an average 12.2 times estimated year-ahead profits in 2006, when Bloomberg began collecting the data, as stocks rose for a fourth straight year. The ratio tumbled to an all-time low of 6.9 times earnings in October 2008 as the financial crisis dragged the measure down 61 percent, and climbed to 12.8 times in September 2009 as equities rebounded.
Shell, Europe’s largest oil company, is trading at 7.6 times next year’s estimated earnings, according to Bloomberg data, compared with an average since 2005 of about 8.5 for the Hague-based company. Eni SpA (ENI) in Rome ranks eighth-cheapest among 28 European oil and gas companies based on next year earnings, the data show. Exxon Mobil Corp. (XOM), the world’s biggest energy company by market value, trades at 11.1 times projected profit in New York.
Analysts estimate DIA, the Spanish discounter spun off from Carrefour SA last year, will boost net income 25 percent next year after a 63 percent jump in 2012, forecasts compiled by Bloomberg show. Earnings at Bentonville, Arkansas-based Wal-Mart Stores Inc., the world’s largest retailer, will climb 6.1 percent in 2013, the data show.
Equity valuations will climb as central-bank stimulus measures force investors to shift to riskier assets in search of returns, according to McCormack, Macquarie’s London-based strategist. The ECB is also helping boost the relative value of stocks compared with bonds by cutting its benchmark interest rate to 0.75 percent and by providing a backstop for the weakest euro-area economies.
The Stoxx 600 pays investors 5.5 percent of their money back in earnings, almost four times more than German government bonds, Bloomberg data show. The dividend yield of 3.83 percent is 1.58 percentage points above the yield from corporate bonds in the region, near the record 1.71 points on Nov. 15, according to data from Bloomberg and Barclays Plc.
“One of the ways for central banks to stimulate growth is to cause a portfolio reallocation among investors searching for greater returns,” McCormack said in a phone interview on Nov. 22. “They have crashed returns on low-risk assets to push investors into riskier ones. Equities are very cheap.”
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