Photographer: Ralph Orlowski/Bloomberg

What to Look For in Europe’s Second Quarter Earnings

  • Forward-earnings multiples have jumped 7.4% since December
  • Equity valuations now fair, putting focus on earnings: Allianz

In the first quarter, upbeat results from European companies dispelled years of gloom and spurred investors to scoop up stocks they saw as cheap. Traders will be harder to impress this time round.

The second-quarter earnings season about to kick off has a hard act to follow: in the first three months of the year, profits increased by the most in more than six years, JPMorgan Chase & Co. estimates show. Aided by receding political risks and stronger economies, those results lifted the Euro Stoxx 50 Index’s forward earnings multiple by 7.4 percent from a December low. With equities now more expensive, investors are stressing the need for another solid quarter for the market to sustain its year-to-date gains.

“We are convinced that the European market can go higher, but the bulk of that now has to come from a pick-up in earnings rather than simply more multiple expansion,” said Marcus Morris-Eyton, a fund manager at Allianz Global Investors, whose team manages 17.5 billion euros ($20 billion). “Valuations in Europe are probably fair now on an absolute basis -- this means earnings are now more important than they have been at other stages of the cycle.”

Strategists have become more cautious on European equities after citing depressed valuations as reasons to buy at the beginning of the year. Earnings revisions for the region have turned negative, ending months of upgrades, and European equity funds last week saw their first outflows in more than three months, Bank of America Merrill Lynch said, citing EPFR Global data.

Allianz’s Morris-Eyton expects low double-digit second-quarter profit growth, which he says is slightly higher than the consensus of about 10 percent. For the full year, analysts see European earnings growing 13 percent, according to a Bloomberg survey.

If profits miss expectations this season, a backdrop of higher valuations and rising bond yields could harm the outlook for equities, according to Emmanuel Cau, an equity strategist at JPMorgan. His year-end target for the Euro Stoxx 50 is 3,650, 5.6 percent higher than the gauge’s current level.

“We do see some upside, and there may be a good buying opportunity toward the end of the year, but we probably want to wait for a formal announcement relating to European Central Bank tapering before buying again,” said Cau, who expects earnings this quarter to gain by less than in the first year on year.

ECB, Euro

The ECB is entering a delicate period, with its 2.3 trillion-euro bond-buying program currently scheduled to end in December, amid a public debate over how fast it should start paring back its stimulus.

Guillermo Hernandez Sampere, head of trading at MPPM EK in Eppstein, Germany, stressed the importance of signals from the ECB for the outlooks for lenders, whose profitability benefits from higher bond yields. He expects banks to post strong results in the second quarter, alongside automakers and consumer stocks.

Investors said they will also watch out for any negative impact from the stronger euro -- the best performing currency among G-10 nations this year -- on Europe’s exporters. Some signs of that may be felt as soon as the second quarter, Morris-Eyton said. Others have singled out the 1.15 level against the dollar as a critical one for equities.

“We are sitting on a large pile of cash, desperately waiting for second-quarter results to find investments, and I think our competitors are doing the same,” Hernandez Sampere at MPPM EK’s said. “I don’t think a lot of investors are trying to run ahead of the market after this year-to-date performance. You are not trying to risk what you have earned so far, so patience is key.”

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