Solid earnings will steady shaky U.S. and European markets

U.S. and European stock markets are in correction mode this week, but the sell-off isn't due to worries about the upcoming earnings season. 

Our research shows that second and third quarter earnings are expected to be robust, continuing an upward trend that brought some of the biggest jumps in profitability among large companies on both sides of the Atlantic in a decade.

Before we dive in, a few notes about the data tables below.

• The column labelled 'Percentage of Cos. Yet to Report' refers to second quarter results in all three tables
• Whilst our main focus is the second quarter, given that it is the one most groups will soon report, we also offer a look at how Q3 forecasts are trending. The columns for those trends are labelled 'Q3 revision mean chg. - 30d'. That stands for the percentage difference between the most recent aggregate forecasts and those from 30 days ago.
• All forecast data was sourced from Thomson Reuters earlier this week, and relate to companies listed on the U.S. S&P 500 index, London’s FTSE All Share Index and for Europe, the Euro STOXX 50 index.
• Cells ended up blank if no companies in those sectors were set to report earnings or revenues in the given quarter. This happens because unless they have a large U.S. listing, British and European companies are only obliged to report statutory earnings twice a year.

Source: Thomson Reuters and City Index

Source: Thomson Reuters and City Index

Source: Thomson Reuters and City Index

Mining and oil earnings surge on

The first thing that catches the eye is that energy and basic resources groups’ earnings are once again set to look the most spectacular. They’re forecast to enjoy the best growth on both sides of the Atlantic, with recent slides in oil and commodity prices having begun in earnest too recently to damp soaring revenues and profits of global miners and oil majors. The lag could be enough to keep their shares on a recovery trend, for now, despite uncertainties about how recent relapses in copper, iron ore, crude oil and other basic resources may hit companies later.  As ever, triple-digit percentage rises foreseen in U.S. energy and materials sectors (oil and mining and related industries are subsets of the latter) need to be interpreted in the context of dramatic collapses in earnings in 2014-2015, when most oil majors, miners and other firms linked to raw materials production reported several quarters of losses.

Techs still hot, but not overheating

The contrast between near-future expectations and current share price action is also striking in the U.S. Information Technology sector. An 11.3% rise is forecast in Q2 profits and 7% rise in sales in the sector that includes the 'FAANG' - Facebook, Amazon, Apple, Netflix, and Google. Even so, shares of these giants have been at the forefront of the stock market decline this week. The sell-offs appear to continue a pattern that emerged earlier in June which saw investor appetite swing from so-called 'growth' sectors (technology is the prime growth sector) to more traditional 'value' plays, like banks, and more established industrial sectors.

The gyrations follow on from technology shares approachig price levels analogous with the dot.com bubble years; albeit price/earnings ratios are mostly tame among large Internet and social media groups. It is left to a handful of turbocharged stocks like Tesla and Netflix to carry the flag of implausible looking P/E ratios this time around. Moderate ratings and expectations of strong tech earnings are at least one factor that points to an easing off of the ongoing share price turmoil in the sector in the very near term.

Italian lenders weigh on European banks

Despite solid profit expectations in tech, the ‘growth’/’value’ pivot won’t go away and the leading business segment among more established industries, in terms of earnings growth, remains ‘financials’, particularly banks. Q2 profits are expected to rise 7% among U.S. financials. Due to similar ‘basis effect’ factors as seen in energy and mining, UK financials’ profits are seen rising 37%. Earnings at large European banks and other finance-linked firms are notably seen declining 2.4% on average. Whilst balance sheet clean ups and deleveraging among banks in that region have been no less intense in that region, continental European lenders remain plagued by weak borrowing costs and, as seen in recent months, the toll of failing banks is not over. This is particularly the case in Italy, where two lenders were liquidated last week, and others are expected to face a similar fate in the medium term.

Consumer conundrum

The consumer staples group (including food manufacturers and retailers) and the consumer discretionary classification shows a mixed performance across the board. Among UK companies, the major supermarkets do not report official earnings or revenues in all quarters, accounting for the blank cells in FTSE All Share consumer staples. For the discretionary UK side, hopes are high that luxury groups like Burberry (the largest) will bounce back in catching up with growth over the last year at European rivals. In the states, Amazon is currently eating the retail sector and this is compounding that segment’s painful transitioning to a lower dependence on bricks and mortar shopping, hence discretionary sector earnings are forecast to tick up a meagre 0.6%.

The laggards

Telecoms are among the expected earnings laggards across Europe the UK and the U.S., though it’s worth bearing in mind that the sector has been much depleted over the last decade, as global M&A reduces the number of companies that can be classified as part of the group. The anomaly here is Europe’s telecom sector, where a proliferation of regional broadband providers has caught the wind of demand. Additionally, the very largest players like Deutsche Telekom are forecast to do much of the heavy lifting for the sector’s earnings. Elsewhere, utilities continue to reflect their historic impediments from high regulation, capped prices and arduous capital requirements (including nuclear decommissioning cost in Germany).

Changes for the better?

The decline in earnings and revenue expectations for most industrial groups shown by the 30-day change in forecast columns partly reflects the natural tendency for caution to set in as earnings dates approach. However, it also probably shows that as market volatility has risen off multi-decade lows in recent weeks, investors are less sanguine about companies’ ability to grow earnings as fast as previously expected. In cases where forecasts decline moderately, this may set up the market for a few positive surprises