A limited downside for European markets, even as cracks appear in the robustness of company profits, was today forecast on the eve of the third-quarter results season.
Deutsche Bank said market expectations for performances in the three months to 30 September were “increasingly realistic” based on a consensus view showing a 17% year-on-year drop in earnings for UK and European constituents of the Stoxx 600.
That’s in contrast to the second quarter, which the bank described as one of “disappointing beats” after earnings topped forecasts but still led to a negative market reaction.
Important dates in Europe’s reporting calendar include 25 October when Lloyds Banking Group (LSE:LLOY) posts third-quarter figures, followed by HSBC Holdings (LSE:HSBA) on 30 October, BP (LSE:BP.) on 31 October, GSK (LSE:GSK) on 1 November, Shell (LSE:SHEL) on 2 November and AstraZeneca (LSE:AZN) on 9 November.
Unlike the summer results season, the build-up to this round of updates has been dominated by heavy selling, as traders speculate about the prospect of global interest rates staying at elevated levels through most of next year.
Deutsche Bank said: “With more realistic expectations and markets already down, we expect the impact of disappointing earnings on markets to be rather muted.”
The bank believes lower inflation and deflation in goods prices combined with shrinking order backlogs and high inventories will lead to lower earnings, especially in the goods sector.
Energy companies could be the exception and beat estimates as full-year earnings revisions have been negative, despite the rise in oil prices by over 20% in the third quarter: “We expect oil prices to remain elevated and to lead to positive earnings surprises.”
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Deutsche Bank regards valuations in the Stoxx 600 as already cheap based on a 12-month forward earnings multiple of 11.9 times, which compares with the 10-year average of 14.7x.
However, it is not expecting the current negative market sentiment to turn positive in the very short term unless earnings and guidance come in significantly better than anticipated.
Looking to 2024, the bank is encouraged that output and orders appear to be showing the first signs of bottoming out at a very weak level. It is slightly more optimistic than the market consensus, which points to 2024 earnings growth at 4%.
The chemicals sector is expected to experience the strongest earnings growth next year, coming from a very low level after warnings by leading players including Croda International (LSE:CRDA).
The bank recently upgraded Chemicals to overweight, due to the sector’s early cyclicality and view that they have already passed through the worst in terms of destocking and lower demand compared to other cyclical sectors such as consumer goods.
Ahead of the results season, RBC Wealth Management today shifted its stance on UK equities to “market weight” from “underweight”. It said valuations appear undemanding, with almost every sector trading on an “abnormally high” discount relative to history.
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The recent market weakness reflects the relatively large exposure of the FTSE 100 index to defensive sectors and to value stocks in financials and energy. The pound’s appreciation versus the US dollar until midsummer also proved to be a powerful headwind given companies in the index derive most of their revenues abroad.
However, RBC Wealth Management’s head of equities Thomas McGarrity believes prospects are improving after the Bank of England paused rate hikes and as rising oil prices boost the energy sector.
He said: “We acknowledge the challenging domestic economic prospects and remain cautious on domestic stocks.
“But we would be alert to opportunities in the energy sector, as well as in leading globally diversified, high-quality businesses whose valuations remain at a notable discount versus international peers listed in other markets.”
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