Proceed with caution: Europe earnings could frustrate


Investors expecting 2014 to kick off with bumper profit growth to match a rally in stock markets could be disappointed, with analysts telling CNBC that a raft of global risks are hitting optimism.

Along with the U.S., European bourses have been cautious this week ahead of corporate earnings.

Earnings for the are expected to grow by just 1.1 percent this quarter, and revenues are expected to rise 2.7 percent, according to Thomson Reuters. In Europe, earnings momentum – a ratio that calculates whether corporate earnings per share is accelerating or decelerating - has been showing a slowdown since late January, according to Reuters. Data last week showed the ratio had slipped from -2.9 percent two months ago to -4.6 percent.

"We are entering earnings season cautious," Gemma Godfrey, the head of investment strategy at Brooks Macdonald, told CNBC via email.

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Indeed, high-profile investors like Dennis Gartman have ventured onto the sidelines, opting to hold cash, until a firmer earnings trend plays out in the next few weeks.

Profit growth is seen as a vital next step to drive stocks higher and, in some cases, justify current valuations in some sectors. So-called momentum stocks, including high-profile names in the technology sector, have seen heavy selling in recent days, as investors have started to question recent run-ups in price.

The S&P 500's current price-to-earnings ratio - an important equity valuation gauge used by investors - stands at 17.67. This compares to figures of below 10 following the global financial crash of 2008. In Europe, the ratio for the pan-European Euro Stoxx 600 Index sits at 16.06.

"From a (price-to-earnings) perspective, overall European equities are trading at levels that are higher than in previous years and so there's a feeling that finding value is hard to come by," Angus Campbell, a market strategist at FxPro, told CNBC via email.

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"Many of the banks and resource stocks still look very cheap, but it's a question of whether you believe they are good value or not. There's plenty of risk out there to suggest they are not."

Campbell believes one of the biggest risks overshadowing the markets are events in China. A debt-fueled boom is leaving analysts looking warily at the country with signs of overheating in the housing market and the rapid deterioration in its economic momentum. The concern for European companies could be if sales start to weaken in a country that is relied upon for expansion.

How to play it?

One potential upside could by the story playing out in Europe with regards to consumer prices. Growth in these prices has struggled in recent months, with some even fearing deflation - when consumer price growth goes into reverse.

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Godfrey told CNBC that this "lowflation" could be increasing competitiveness in southern European nations by capping labor costs.

"Companies with domestic focus in the higher growth areas of southern Europe may offer good news, in contrast to those in the 'core' selling to emerging markets," she said.

"Investors have been focused on buying not just the periphery for more accelerated growth and earnings upside but also on the small and mid-caps. This has been to better access the domestic consumer. Compared with large caps and historical valuations, there's further to go."