When will the earnings momentum rise on the European equity markets?

When will the earnings momentum rise on the European equity markets?
When will the earnings momentum rise on the European equity markets?
Ⓒ iStock.com
Share post:

The stock exchanges have been moving sideways and down for weeks. There are of course enough uncertainty factors such as the Greek crisis, the correction on the Chinese stock exchange, and the expected interest rate increase in the USA that can serve as explanation. However, one factor that has (so far) been left out of the equation is the fact that company earnings are hardly growing. The increase on stock exchanges is fundamentally justified if the valuation levels are rising across the board without earnings growth (e.g. price rises due to the low interest rates) or if company earnings themselves are rising (thus justifying the valuations). The interest rates can actually not fall any further, which means that the stock exchanges cannot get any impulse from that end.

How does the other factor, earnings growth, look? There is no clear answer to that question. Some market participants are rather sceptical. In the following I will try to shed some light on these factors, company earnings and earnings momentum.

Worldwide quick recovery of company earnings after the financial crisis

Published earnings (EPS), long-term earnings trend (EPS long term), and company earnings generated on average over the past 10 years (Shiller method) 1975 – 2015

Source: MSCI World; as of July 2015; Shiller method green line

Source: MSCI World; as of July 2015; Shiller method green line

 

The chart highlights the fact that over the past 40 years (June 1975 – June 2015) company earnings have been rising at a relatively stable rate of 5.3% per year (long-term earnings trend – red line), taking into account cycles. After the financial crisis (2008) company earnings saw a relatively quick recovery, embarking on a trend that has been held for the past three years. However, over the past four months, earnings have been sliding slightly but steadily. This is a warnings signal that we have to keep an eye on: without earnings growth, no further price increases can be justified, given the current valuation. Only once earnings start rising again can a price increase be fundamentally justified.

Earnings growth only in some sectors

Earnings growth has become a rare commodity in the current environment, but it still exists – albeit only in specific sectors. Among them are the IT sector, the financial industry, and consumer goods. Especially consumer goods have continuously reported falling earnings in the past months, and we may have seen the beginning of a trend reversal. The high-flyer of the past months, i.e. the biotech sector, has recorded earnings growth of 100% in less than three years. But most recently it has recorded falling earnings, joining the traditional pharmaceutical companies. The situation in the energy sector is dramatic, with earnings falling by more than 30% in the past half year. Among the sectors that have incurred falling earnings are the industrial sector, raw materials, and telecoms.

The European earnings lack momentum

Earnings (EPS) generated in Europe (ex UK), long-term earnings trend (EPS long term), and company earnings generated on average over the past 10 years (Shiller method) 1975 – 2015

Source: MSCI

Source: MSCI

While Europe has rising earnings to show for in contrast to the global trend, said trend lags expectations. There is currently a significant gap between Europe and the long-term EPS trend (red line). In fact, earnings are back at the level of 2000, i.e. of 15 years ago!

Will earnings boost again?

The expansive monetary policy of the European Central Bank and the recently weak euro should facilitate a significant boost of earnings for companies. However, falling demand from the emerging markets, in particular from China, somewhat contradicts this scenario.

The general question is whether a return to the long-term earnings growth trend will be possible in the short run. The growth sectors of technology and biotech are underrepresented in Europe. In order for earnings to return to their long-term trend growth, they would currently have to rise by 47%. For the time being, this is unlikely to happen.
 

RESPOND TO THE ARTICLE

Legal disclaimer

This document is an advertisement. Unless indicated otherwise, source: Erste Asset Management GmbH.Our languages of communication are German and English.

The prospectus for UCITS (including any amendments) is published in Amtsblatt zur Wiener Zeitung in accordance with the provisions of the InvFG 2011 in the currently amended version.Information for Investors pursuant to § 21 AIFMG is prepared for the alternative investment funds (AIF) administered by Erste Asset Management GmbH pursuant to the provisions of the AIFMG in connection with the InvFG 2011. The fund prospectus, Information for Investors pursuant to § 21 AIFMG, and the Key Information Document can be viewed in their latest versions at the web site www.erste-am.com within the section mandatory publications or obtained in their latest versions free of charge from the domicile of the management company and the domicile of the custodian bank. The exact date of the most recent publication of the fund prospectus, the languages in which the Key Information Document is available, and any additional locations where the documents can be obtained can be viewed on the web site www.erste-am.com. A summary of investor rights is available in German and English on the website www.erste-am.com/investor-rights as well as at the domicile of the management company.

The management company can decide to revoke the arrangements it has made for the distribution of unit certificates abroad, taking into account the regulatory requirements.

Detailed information on the risks potentially associated with the investment can be found in the fund prospectus or Information for investors pursuant to § 21 AIFMG of the respective fund. If the fund currency is a currency other than the investor's home currency, changes in the corresponding exchange rate may have a positive or negative impact on the value of his investment and the amount of the costs incurred in the fund - converted into his home currency.

This document serves as additional information for our investors and is based on the knowledge of the staff responsible for preparing it at the time of preparation. Our analyses and conclusions are general in nature and do not take into account the individual needs of our investors in terms of earnings, taxation, and risk appetite. Past performance is not a reliable indicator of the future performance of a fund.