With nearly 90% of US fourth-quarter results now in, earnings are beating low expectations, though that doesn’t justify the premiums that US equities in general are fetching. But European companies are also beating expectations (40% have reported so far), they are much more attractively valued and they have more room for earnings to grow.
Since the global financial crisis, it has been the norm for analysts to set the bar too low in their quarterly US earnings forecasts; so beating expectations is not out of the ordinary. In aggregate, US earnings are on pace for a 2.0% quarterly gain, which is not terribly exciting. Strip out Apple, and earnings have fallen 2.1%. Sales have been roughly flat.
Some areas are performing better than others. Smaller, domestically-focused US companies are outperforming America’s big multinationals, which have seen their overseas revenue eroded when translated back into dollars. Not surprisingly, the energy sector has taken a big hit from falling oil prices. But lower oil prices cut both ways – US industrial companies are performing well due to lower input costs.
In Europe, the energy, consumer staples and industrial sectors have had weak earnings, while consumer discretionary, technology and utilities companies have seen solid growth. Overall, earnings look set to grow for the fifth consecutive quarter, and seem to be returning back toward their longer-term growth trend. Profit margins have continued to expand, reaching a healthy 7.6%.
European equities are likely to remain volatile while the Greek saga continues, but we’re sceptical about a Greek exit, and think European equities will continue to outperform US and global peers as they have done so far this year.
During their recent battering, we have also remained positive on quality energy majors with the ability to keep paying healthy dividends. Forecasts for oil prices are all over the map – for example, BP expects $50/barrel oil prices for some time while ENI predicted $90 by year-end. But it’s been interesting to see how disciplined capital spending in the energy and materials sectors has enabled dividends to be maintained and, in some cases, even to be increased.
What that means is that investors in these companies are getting paid to wait for a recovery in oil and commodity prices, whenever that may be. However, we would avoid “upstream” exploration and development companies that are vulnerable to cuts in capital spending.
While earnings forecasts have been slashed for energy companies, earnings estimates for the beneficiaries of lower oil prices – consumer and industrial sectors – have yet to be revised up. In fact, they’ve both seen downgrades, and we expect these sectors to generate some of the biggest positive surprises.