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Investors set to look beyond bad European earnings

As Europe’s macroeconomic data begins to show signs of stability, stock market investors are set to look beyond what is shaping up to be a grim set of first quarter European company earnings figures

Equity markets always seek to price in future prospects and often react before analysts change earnings outlooks and before corporations alter guidance. Strategists don’t expect markets to be any different on the way up.

Some banks have already advised clients to extend their shift into cyclical stocks from defensive plays, although many remain cautious and see the latest market upswing as no more than a bear market rally.

“The corporate earnings numbers for the first quarter in general are going to be poor but I think the market will probably look through that,” said Robert Parker, vice chairman of asset management at Credit Suisse.

Dutch-based Philips Electronics on Tuesday missed expectations for a profit, posting a €74 million loss instead. Its stock ended up 3.3% on the day after the company promised to accelerate restructuring.

Parker said he expected the latest stock market rally, which as seen the pan-European FTSEurofirst 300 gain 23% since its low of March 9, to last a little bit longer than the consensus view.

“We are going to have a setback but rather than the setback being now there is the chance of the setback could be delayed until late May or June when the market is significantly higher than it is now,” he said.

Goldman Sachs expects European corporate earnings to fall 38% in 2009, revised from a decline of 16%. But it expects 2010 earnings to grow 19% from its previous forecast of 8%.

“We think that the buy-side is already using more conservative numbers (than the consensus view), so even if there are downward revisions and/or negative surprises, they might be met with a positive market response,” the broker said in a report last week.

It recommended investors move further into cyclical stocks from defensives, and it upgraded industrials to ‘overweight’ and downgrading healthcare to ‘neutral’. Goldman Sachs, however, said the market was not out of the woods and it was skeptical this was the start of a sustainable bull market.

The latest rally could last for some time as long as the pace of economic deterioration moderated, despite weak corporate earnings for the Q1, said Robert Parkes, UK equity strategist at HSBC.

“The market is very focused on economic indicators and the fact that they look less bad, as long as that profile continues, could help sustain the current rally,” he said. “This is why the market prepares to live with earnings disappointments in Q1,” he said, adding that HSBC estimated UK companies would post a 35% fall in 2009 earnings, and a 50% drop if financial stocks were excluded.


The US trade deficit shrank in February to its smallest level since November 1999, backing the view that the drop in first-quarter gross domestic product was probably not as steep as the previous quarter’s 6.3% annual rate.

The US Federal Reserve said on Wednesday economic activity in some parts of the country appeared to be stabilizing, and other data showed a decline in factory activity in New York state eased this month and national homebuilder sentiment rose.

In Europe, factory output for the UK and France fell less than expected in February, although industrial production in the 16 countries using the euro plummeted by a record 18.4% year-on-year in the same month.

“Analysts have already cut their numbers a fair way and we think they have further to go. But the last leg down doesn’t necessarily mean stock prices are going to fall,” HSBC’s Parkes said.

JPMorgan also said the consensus view rarely ended up being realistic at the bottom of the business cycle as it found the last 10-20% of earnings per share downgrades were usually not realized.

“Given signs of a stabilization in high frequency macro indicators, a trough in quarterly EPS in the H1 2009 appears reasonable, adding to the probability that the market has already seen the lows,” the broker said in a report.

“The first part of an equity rebound is not driven by EPS upgrades. On the way down, the market moved significantly ahead of analyst downgrades and ahead of reductions in corporate guidance; we believe the same will apply on the way up.” (Reuters)