The Economist ran a good piece this week on declining earnings expectations for US companies. The big story seems to be that we are mid-way through a slowdown in profits growth. But that’s probably a more positive story than in Europe where investors have been worried about a sharp slowdown – negative yields on Euro government bonds certainly suggests a real fear of recession (see below).
But my hunch – and its nothing more than that – is that investors have been a little too bearish on European equities, especially now that the Eurozone has a new governor who will probably want to signal a clear path towards monetary stimulus.
In this scenario, we could see a surprise rally in Eurozone stocks especially if they surprise to the upside in terms of corporate earnings. We’re at the beginning of the Q2 reporting season – what do the numbers tell us? According to Morgan Stanley’s European equity team an initial look at these numbers suggests the headline of “Another low-quality beat”.
Here’s the quick summary from the report this morning…
“The limited 2Q results tracked so far show a modest beat, but helped by lowered consensus expectations. European Earnings have delivered a modest EPS beat so far… We present our initial take on 2Q results on the 46 companies that we have tracked so far.35% of companies have beaten EPS estimates, while 26% have missed so far, giving a net beat of ~9% of companies. Weighted earnings have beaten by 2.2%, but the median stock has actually missed estimates fractionally (40bp).
“…but lowered expectations, softer sales and a number of notable profit warnings suggest the beat is low quality. When we published our 2Q earnings preview just a week ago, consensus expectations were for -0.9% earnings growth in 2Q. In the last week, expectations have dropped to -4.0%, so the bar has been lowered just before results. Actual growth is tracking at just -3.9%. Softer sales than earnings (a net 2% of companies have beaten revenue estimates) and a number of notable profit warnings also suggest the headline EPS beat is a low-quality one. “
So yet again, the numbers don’t look quite as bad as everyone expected but that’s because analysts have been busily lowering numbers beforehand.
Economics commentator Frances Coppola – author of an excellent book on peoples QE available HERE – has rightly drawn attention to the plethora of government bonds that trade at negative yields to quite long durations. The blog – available HERE – focuses on what must be one of the oddest anomalies in bond investing: that US Treasuries have a similar yield curve to Greek govies. The first chart from Coppola’s blog is below and shows that the new Greek government only has to pay around 3% per annum in interest rate to borrow for more than 20 years. And let’s not forget what Greece has been through – and the obvious future risks in such a trade.
The second chart shows the yield curve for US govies. Looks a bit similar doesn’t it, although the absolute level of yields are slightly lower – around 0.50% across most durations.
I think Ms Coppola is spot on when she remarks that “am I the only person who thinks it is completely insane that the 10-year US Treasury yields the same as the 10-year Greek government bond? Anyway, just look at that inversion. The Fed is way out of line with other central banks. The dollar is soaring, and the President is cross. Surely the Fed will cut rates any day now.”
Welcome to QE4, then Negative Interest rates, followed by a new world order of Helicopter Money.