When markets gyrated at the turn of the month, US and Japanese stocks had the cushion of an earlier surge to fall back on. In Europe, the rout hit share prices that had been weakening since May. An earnings season dominated by pessimism from many of the region’s bosses has vindicated investors’ caution.
The change in tone is stark after first-quarter results statements had sounded encouraging. The European Central Bank’s rate cut in June also underpinned expectations that the region might be on the cusp of an economic upturn, even as investors digested political surprises in France. But before the mid-year reporting season even started, a spate of profit warnings reset the mood — notably from industrial firms including Airbus SE and Carl Zeiss Meditec AG and consumer-facing companies such as Burberry Group Plc, H&M Hennes & Mauritz AB and Deutsche Lufthansa AG. These were to prove a taste of worse to come.
European corporations didn’t perform that badly in the second three months of the year. They’re generally growing sales again after several successive quarters of declines. Profit margins also have been strong. So when it comes to earnings, more companies have beaten forecasts than missed them. The financial services sector has led these positive surprises.
But the comments on the outlook have given pause. The repeated message is that customer demand is weak, in particular from China — a key market for the luxury, automotive, semiconductor, chemicals and commodities industries. With the US slowing too, “the nascent European recovery is vulnerable, again, to external forces,” analysts at UBS Group AG warned last month. That pattern is clear in the stark underperformance of UBS’s index of China-exposed European stocks, including luxury and automotive firms.
The pricing power that many companies enjoyed as economies reopened after the pandemic, with consumers rushing to spend and supply chains still gnarled, has faded. A hoped-for recovery is on hold in the so-called consumer discretionary sector and appears only partially underway in what should be the more resilient consumer staples industry. Wednesday’s updates from sneaker maker Puma SE and ad giant WPP Plc, citing weak Chinese demand, just reinforced the trend.
Roughly 40 companies have cut guidance this earnings season, more than double the number at the first-quarter stage, according to analysts at Bank of America Corp. Investors have often sold more resilient stocks to lock in profits, and the overall data from European companies has failed to provide the catalyst needed to push valuations higher, says Bloomberg Intelligence.
It should be no surprise then that estimates for European earnings in the third quarter have ticked down — as they have for 2024 as a whole. Indeed, UBS strategists anticipate earnings growth will be zero this year and next.
The bull case for European stocks is that they are still cheap relative to the US when priced relative to predicted net profit. The defensive qualities of the low-growth UK market could also come into favor now if stock market volatility continues.
But this recent history, coupled with the equity market turmoil, is a particularly unhelpful backdrop for deal activity in Europe. The Stoxx Europe 600 index is now only just in positive territory this year, while the S&P 500 is still up around 10%. When shareholders suffer very large losses on multiple single stocks, as they have done in these last few weeks, it can make them especially risk averse. The narrative from the C-suite is hardly going to inspire investors to take a punt on potential initial public offerings like aspiring debutant Shein, the fast-fashion retailer.
Investors in the US may feel like they’re having a terrible time. They only have to look at Europe to feel better.
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