Daily Management Review

Following Europe's Great First Quarter, Investors Predict Turmoil Ahead


Following Europe's Great First Quarter, Investors Predict Turmoil Ahead
Big European firms produced much better-than-expected first-quarter profits, despite a tough economic background that includes rising inflation and interest rates.
However, European stocks are down from a 14-month high in April, as investors are concerned about the global economy's health, weakening client demand, and profit margin pressures.
Approximately half of the STOXX 600 businesses have reported first-quarter results, with two-thirds exceeding estimates, a greater performance than in most quarters, when approximately half of companies normally beat profit estimates.
"It's still the case, that a resilient consumer, supported by excess savings and a strong labour market continues to absorb higher prices and support corporate profitability," wrote Bernstein strategists Mark Diver and Sarah McCarthy.
While banks in the United States and Switzerland had to be rescued, first-quarter results from the eurozone's largest bank, BNP Paribas, British lender Barclays, and Germany's largest bank, Deutsche Bank, all exceeded expectations.
Nestle and Unilever, the maker of Dove soap and Ben & Jerry's ice cream, posted better-than-expected results as price hikes offset decreasing volume.
LVMH, Europe's largest listed corporation, posted excellent sales as China recovered strongly after COVID limitations were lifted.
Earnings at STOXX 600 businesses are anticipated to rise 7.3% in the first quarter, up from a 2.5% fall predicted only four weeks earlier, according to Refinitiv I/B/E/S statistics.
However, the pan-European market index is about 7% behind its all-time high, set in January 2022, before the Ukraine incursion.
It is down around 1% since the start of the earnings season, when it reached its best level since February 2022, thanks to a surge fueled by China's post-COVID openness and falling energy prices. The present reductions are roughly consistent with worldwide market conditions.
According to BofA, European equities have suffered outflows for nine weeks in a row.
JP Morgan downgraded eurozone equities to "underweight" last week, noting that they had already recovered 30% against the US since their lows in September.
"(Strong earnings season) was not enough to bring global markets to make new highs probably due to the clouds that are still present on the horizon," said Luca Finà, head of equity at Generali Insurance Asset Management, mentioning rising cost of capital and default risks of the U.S. debt ceiling.
The strong corporate margins witnessed in the first quarter are expected to deteriorate later in the year.
According to Refinitiv I/B/E/S forecasts, STOXX 600 businesses will report net profit margins of 11.4% in the first quarter, up from 10.2% in the previous quarter.
According to Refinitiv, margins are expected to fall to 10.5% in the third quarter.
"(If) Q1 sets an example for 2023, sales growth could remain resilient, but margins will have a hard time improving in this context of higher (interest) rates," said Florian Ielpo, head of macro at multi asset group Lombard Odier Asset Management.
"Higher rates mean higher funding costs and lower CAPEX at the moment, and eventually it will mean a lower demand, declining sales and a lower pricing power as the consumer end will come under pressure," he said.
New data from China suggest that inflation has levelled off and imports have fallen, casting doubt on the global economy's prospects.
Analysts also warned that consumers in Europe, who have fared better than many predicted in terms of cost-of-living adjustments, may soon run out of savings.
According to Barclays, cyclicals generated the majority of the EPS beats, driven by industrials and consumer discretionary.
The European Commission stated on Monday that it expects euro-zone inflation to stay persistently high this year, at 7%, with economic growth of 1.1% this year and 1.6% in 2024.
ASML Holding NV, Europe's largest technology company, surpassed profit projections but acknowledged some customer concern.
Vodafone wants to lose 11,000 positions over the next three years after warning that poor performance in its largest market, Germany, will hurt cash flow.
However, there has not been a flood of corporations lowering their earnings predictions, offering a cushion for European equities.
"Guidance has been less positive in Q1 but there has been no material rise in percentage of firms guiding lower," Barclays said.