European shares capped by pessimism and fear

A near-decade long earnings recession for major European companies continued in recent quarters and is not over yet, if pessimistic forecasts are anything to judge by.

Earnings depressing

A tally of fourth quarter 2015 earnings compiled by Thomson Reuters last week showed these were 8% below forecast, on average.

That was well below the 4% long-term negative surprise factor, and also missed the bad surprise factor of the last four quarters by 4 percentage points too.

To be sure, there were pockets of strength.

Of the 308 STOXX 600 index firms that had reported Q4 sales up to 31st March, 57% beat analyst forecasts vs. 55% that typically do so according to Thomson Reuters.

But the underlying picture was less promising.

Q4 revenues on average were expected to fall 5.3%, whilst excluding the financial sector (forecast to be the strongest) earnings were expected to fall 3.1%.

Of the 256 STOXX firms that had already reported profits, 44% beat forecasts whereas 49% normally do this.

Negative growth with those rates?

Europe’s rather elongated and diverse corporate reporting phases mean some firms will already have released first or even second quarter results for 2016 whilst others still had Q4 finals ahead.

Either way, we’re forced to conclude that the trajectory of corporate earnings this year is pretty much unmistakeable.

Our assessment is that consensus forecasts for 2016 European EPS growth has fallen to c. 0.5%.

If that is correct, it would represent the weakest growth rate since Q1 2009.

Along the road to the end of 2016, growth for quarters Q4 2015 to Q3 2016 inclusive is seen at 32%, -16%, -1% and -3% on the year respectively.

That would come after two successive quarters of negative earnings growth by 500 key European companies tracked by Bloomberg.

Brexit ‘premium’

An additional pressure on European shares that has potential to increase in the run-up to the UK’s referendum on EU membership, is the tendency for traders to rack up sterling volatility to the benefit of the single currency as ‘Brexit’ fear grows.

The euro is justifiably inversely related to most major European stock markets due to the impact on Eurozone exporting companies when the euro rises.

Overnight GBP/USD vol for the specific date of the ‘Brexit vote’—23rd June—peaked at 90% on Monday in the most liquid tenor.

That implied an expectation of trading that would be among the Top 5 craziest occasions in the last 26 years, including market conditions seen during the Lehman collapse, and after the UK left the European Exchange Rate Mechanism.

At the same time, a record gap between sterling and euro implied volatility appeared to pave the way for a corrective shock if euro bulls are proved wrong.

Euro net shorts continued to decline at the world’s biggest traders last week, according to the latest CFTC data, to their lowest levels in roughly a month.

But following the risk scenario to its logical conclusion, it’s still possible to suspect under-priced risk.

A more optimistic reading of the above data is that sterling volatility may have peaked—trading just before this article was published suggested the pound had regained some poise—also that European earnings may be at a turning point.

Positive factors include an ultra-accommodative European Central Bank, rebounding oil/commodity prices, and the fact that years of cost reductions amid economic recession have optimised firms’ ability to capitalise on record-low borrowing costs.

At best though, with few major European corporate data points in the week ahead—save for Hennes & Mauritz first quarter results on Wednesday, the market is likely to react to economic data releases.

A raft of PMI updates on Tuesday will be followed by a Chinese service sector PMI on Wednesday, before Federal Reserve and ECB minutes on Wednesday and Thursday respectively.

All of the above offer ample scope to sustain the dollar’s recent weakness which has inversely buoyed the euro and weighed on Eurozone shares.

Super-sector laggards

From a technical perspective, the jury is still out, looking at the Euro Stoxx 50 index of blue-chip ‘super sector’ leaders.

DAILY CHART

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After being capped by resistance that was former support at 2920 earlier this year, the index was funnelled through a bearish triangulation and has been pointing lower since mid-March.

The European aggregate partly reflects weakness of the region’s highest profile index, the DAX (not pictured), which topped out just above 10100 last month before losing 3% to date.

Euro Stoxx 50 may gain more signal import should it break sustainably below hard-won levels taken in February, under 2737 support.

If 2737 goes, few feasible underpinnings are visible beneath, before levels closer to lows for the year near 2555.

On the other hand, trend indicators (see sub-charts) are ambiguous currently.

The Slow Stochastic diverges mildly and the ADXR gauge of trend strength gives a ‘no trend’ reading below 20.

The weak trend reduces predictability and might well truncate the path lower or even obviate further weakness entirely.

But the index will certainly not regain much poise before it rebounds above medium-term gauges, like the dotted white line of its 21-day exponential moving average (EMA).

Short-term trading of City Index’s EU Stocks 50 Daily Funded Trade also showed unmistakeable signs of caution at the time of writing.

HALF-HOURLY CHART: EU STOCKS 50 DFT

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The trade remained weaker in half-hourly intervals than its 144 period/3-day EMA, having butted up against that threshold earlier in the session.

EU Stocks 50 DFT also had to contend with a descending trend that had sealed the upside since 10th March, as well as loss of 38.2% Fibonacci retracement support based on its February-to-March ascent.

The trade looked very likely to continue weakening whilst beneath the barriers mentioned.

In turn, that weakened the odds of a decisive medium-term bounce by the underlying index too.