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European shares hit by weak earnings outlook

* FTSEurofirst 300 falls 0.5 pct, Euro STOXX 50 down 0.6 pct

* Subdued start to U.S. earnings season dents sentiment

* EADS rises 5.3 pct as BAE merger talks collapse

By Francesco Canepa

LONDON, Oct 10 (Reuters) - European shares fell for a third straight session on Wednesday, dragged lower by expectations of weak corporate earnings in the region after a subdued start to the U.S. reporting season.

Merger and acquisition news provided one of the main drivers of the day when EADS

and BAE Systems

called off the world's largest defence and aviation merger, sending EADS shares up and BAE down.

Shares in Bang & Olufsen

fell 3.8 percent in volume nearly four times their daily average as the Danish stereo and television maker recorded a much wider than expected quarterly loss due to weakening demand for luxury goods.

It added to investor concerns after U.S. bellwether aluminium maker Alcoa

cut its demand forecasts and oil major Chevron Corp issued a profit warning. The STOXX 600 index of Europe's 600 largest companies fell 0.6 percent.

"I think the earnings season is going to be very disappointing," said Robert Quinn, chief European strategist at Standard & Poor's Capital IQ.

"There may even be the case for a reversal (of the recent equity rally), with the macro side still negative while the impulse from policy won't be contributing very much."

He expected the STOXX 600 to end this quarter flat to lower after gaining nearly 7 percent in the previous three months, boosted by the European Central Bank's pledges to save the euro and support the region's struggling economies.

The index has retreated 2.8 percent from a 14-month high hit in mid-September as Spain has hesitated to apply for a bailout that would pave the way for ECB intervention to begin, while investors have turned their focus to the bleak outlook for the European economy and corporate profits.

STOXX 600 companies are expected to miss earnings estimates by an average 1.1 percent in the third-quarter reporting season, due to start later this month, according to Starmine data.

"The main risk is a raft of downgrades on the earnings season in the cyclical sectors, especially in technology and industrials," said Claudia Panseri, global equity strategist at Societe Generale.

Panseri advised her clients to steer clear of industrial and tech stocks, where she saw the greatest downside risk to earnings. She recommended positioning in sectors where room from downside surprises is limited such as utilities in peripheral euro zone countries and banks in the United States and Europe.

She added utilities had started to cut capex and were poised to report an increase in earnings while ebullient financial markets in the third quarter were likely to result in healthy trading profits for banks.

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EADS, BAE

Traders said many investors were reluctant to make big bets before corporate earnings are released, resulting in light trading volume on the STOXX 600 of less than 80 percent of its 90-day average.

That made M&A news a key focus when EADS and BAE Systems called off their merger plans and pinned the blame on Germany for wrecking the $45 billion deal.

Shares in EADS rose 5.3 percent in volume more than eight times their 90-day trading average as they decoupled from the proposed 60-40 swap ratio with BAE's shares, which fell 1.4 percent in twice their average volume.

"Now that the deal has failed, that alignment has no reason to exist," a Paris-based analyst said.

The end of the talks proved profitable news for the hedge funds and arbitrage traders using a so-called 'Chinese spread', which involves buying shares in the potential buyer, EADS in this case, and selling stock in the target, BAE.

With EADS stock up around 8.5 percent since mid-September and BAE down 10 percent, however, such merger arbitrage trades set up within days of news of the talks were ahead by a hefty 18.5 percent on Wednesday.

EADS was the top gainer on the FTSEurofirst 300

index on Wednesday, with the pan-European index down 0.5 percent at 1,090.03 points by the close.

The euro zone Euro STOXX 50

index fell 0.6 percent to 2,456.54, testing support in the 2,450 area, corresponding to early September lows.

(Additional reporting by Blaise Robinson in Paris and Sudip Kar-Gupta; Editing by Hugh Lawson)

((francesco.canepa@thomsonreuters.com)(0044)(0)(2075423871)(Reu

ers Messaging: francesco.canepa.thomsonreuters.com@reuters.net))

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