European earnings may be at inflection point: Strategist

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After almost six years of no earnings growth for Europe, there is hope the region's companies hit an inflection point during this year's third quarter, according to the Head of European Equity Strategy at UBS.

With over half of European companies having already reported, Nick Nelson says the recovery seen in revenue growth is key to driving positive momentum in earnings.

"Revenues have had the best net beats for five quarters…this is critical because we've had no earnings growth in Europe for six years and the last year and a half we've had no topline growth. And it's been very hard for companies to generate EPS (earnings per share) growth with no topline growth."

"To see that starting to improve, it's just a glimmer but it seems we may be at an inflection point there," he continued.

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On a sector basis, pharmaceutical, auto and banks stocks have enjoyed the highest amount of net beats so far in the third quarter, according to UBS. Those struggling along with the most misses are food and beverage and tobacco stocks – a result which matches the broader deterioration in earnings momentum experienced by food producers.

Slicing up the market a different way, cyclical stocks have outperformed defensives in terms of earnings momentum during the most recent quarter, say analysts at UBS.

Consensus has been overly optimistic for a long time, with Nelson pointing out that year after year of expectations for 8 – 15 percent EPS growth have been met by flatlining reported numbers for nearly the past six years.

However, the UBS strategist thinks this year, the lower end of such a forecast range may be achievable going forward, driven by strength in certain financials and energy stocks.

Looking ahead to 2017, Nelson says, "We think there's a bit of topline growth that comes through, there's a little bit of operational leverage, you have got some base effect obviously from oil. In Q1, oil will be up dramatically - maybe the banks as well - and both of those will get you to around 8 (percent EPS growth) but we struggle to get to the mid-teens, we think that's too high."

And this level of accomplishment should be enough to give markets a welcome boost.

"The market would cheer an 8 percent growth rate, that would be good enough," he added.

One reason for the UBS team leader's optimism is a comparison of downgrade and upgrade trajectories during the third quarter. Previous years have often seen a raft of earnings' forecast downgrades during the quarter, lowering expectations ahead of announcements and thereby diluting the credibility of any positive surprises that come through.

Nelson says the fact that August actually saw net upgrades while September and October saw a more or less equal number of upgrades and downgrades suggests these beats may be more credible than usual.

"That's another positive sign when we look at the data," he posited.

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