Goldman Sachs Is Skeptical About a Big Profit Rebound in Europe

Europe’s best earnings season in two years has stirred up a whole lot of enthusiasm from investors itching for that rebound.

Not so fast, say Goldman Sachs Group Inc. strategists. The region’s companies are nowhere near as profitable as those in the U.S., with a widely-flagged gap in margins that remains near its biggest in three decades. While that may narrow, it won’t necessarily be to Europe’s benefit. The difference is due to extremely high American margins, now under pressure from improving wages, rather than to European profitability being abnormally low.

“One thing that militates our enthusiasm for a large earnings growth story is that margins are not at recessionary lows,” Goldman Sachs strategists led by Peter Oppenheimer wrote in a March 2 note. “We are not of the view that a large catch-up up either from trough levels, or compared to the U.S., is likely.”

The S&P 500 Index’s margin on net income, a measure of how profitable a company is, is about 300 basis points higher than for members of the Stoxx Europe 600 Index excluding financial stocks, according to Goldman Sachs. That’s almost three-quarters more than the average going back to 1986 and only slightly off a peak of 329 basis points in 2015.

But taking out technology companies -- one of the biggest drivers of U.S. profitability in the latest bull market -- trims that gap by half. Technology firms make up about a fifth of the S&P 500, versus just 4 percent for the Stoxx 600.

While some equity strategists are yet again predicting that this will finally be the year European profits deliver, the region’s tendency to fall short isn’t far from memory. Some cracks are starting to show -- investors pulled the most money from funds tracking European stocks in 13 weeks, while adding another $6.7 billion to U.S. stocks.

“The room for catch-up looks limited,” the Goldman Sachs strategists wrote.

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