European stock market: conclusions from the earnings season

Author: Richard Brown, European equity portfolio manager at Janus Henderson

What have we seen so far this year, or what was the backdrop of this earnings season? Of course, we saw this really astonishing risk rally during the last quarter of last year. Starting in October, we began to see that inflation was lower than expected, which was met with strong pessimistic rhetoric from central banks around the world, to which equities and fixed income responded. However, we have not really seen that change earnings expectations as far as this season is concerned and that has two aspects.

Firstly, no one really expects those lower rates to have made their way into the real economy or, indeed, into corporate profits. So the benefits of those lower rates are not yet evident. I think we will have to wait for the next two quarters to check it.

Secondly, the inventory reduction cycle. Following the supply chain disruptions associated with the COVID pandemic, many companies in Europe and the rest of the world ended up with quite high inventory levels and we have seen how they have been eliminated over the course of the last quarters.

Sector rotation

All of this has anchored expectations for this season, which has meant that the market has been somewhat directionless so far in 2024. By this I mean that we have seen a lot of sector rotation, where last year's winners have not made big purchases nor have they made big sales; and the same has happened with the losers. We have also seen that the response to earnings announcements has been more extreme than usual. Thus, they rise more with good news and fall much more with bad ones. Meanwhile, smaller companies continue to perform worse than large ones. Therefore, even though we have been in this period so far in 2024, where stock returns have been positive, it is clear that there is still a great deal of nervousness about the direction of the economy from this point and what that means in terms of corporate profits and in terms of stock valuations.

Therefore, looking at what we have heard from companies more specifically, at this moment just over 50% of European companies have announced their fourth quarter earnings. Expectations were low, but they have been significantly reduced. In fact, the first few weeks of this earnings season have been some of the worst we have seen in over a decade. And which sectors have driven it? Perhaps first the most positive ones like the technology sector. The way AI manifests itself in Europe is through semiconductor companies and these have reported some very significant numbers, more daily use cases of how AI can be integrated into our everyday life and this has been reflected in the earnings.

Positive Aspects

On the other hand, I would say that the only surprise we have seen is that a recovery in phone and smartphone shipments is beginning to be seen worldwide after what have been a couple of difficult years.

The second area of positive results has come from the aerospace sector. Here we have seen that many European companies depend heavily on the growth of air traffic and the service contracts they sell with their planes. In fact, we have seen that air traffic growth continues to recover quite well after the COVID pandemic. All this before we have seen Chinese tourists returning to travel again in a significant way and that is what we are going to monitor over the course of the next two quarters. It has been a sector that has produced very representative earnings.

On the negative side of things, we had a large pharmaceutical capitalization excluding Novo Nordis (producer of Wegovy, the weight loss drug). But I believe that big pharma continues to struggle for innovation and growth and, again, this has been very evident during this earnings season.

And in addition to that, consumption, both discretionary and basic, I believe serves to highlight that the cost of living crisis continues to significantly affect the consumer in Europe. Although there are even some glimmers of optimism, what we have seen most recently is that wage growth adjusted for inflation, that is, people's wages catching up with inflation in general have a positive influence. And we have started to see this reflected in some of the companies that have lower-priced consumer items like some of the jewelry manufacturers, for example. In Europe in a way it has resisted the trend of consumers in general and has produced very good results as we have seen in recent weeks.

And, finally, in recent days we have learned the latest inflation figure. In fact, it has surprised on the upside in the U.S. and a bit on the downside in the UK. This reminds us that we do not believe that the fall in inflation follows a straight line. I think there are still many shocks to come, and we should not trust too much the aggressive consensus forecasts about the fall in inflation over the next 12 months, which place it back at the 2% target over the course of the next 18-24 months. We continue to believe that inflation will remain more stable than we have seen in the past. And, for the moment, our working scenario over the next few months is more a stagnation of the Fed than a significant turn.