| FOCUS 16/01/2019 1
FOCUS | EMEA
17 January 2019
Earnings: Much ado about nothing
Please refer to important information and
MAR disclosures at the end of this report
EQUITY & DERIVATIVES
KEY MESSAGES
The earnings season kicks off in Europe next week.
Although we expect earnings to be below current
market consensus, we believe equity markets are
currently pricing an earnings recession which we
think is unjustified.
We believe European small and mid-cap stocks
could surprise the most in the current earnings
season.
We maintain a positive bias towards European
value sectors including Banks, Insurance, Oil & Gas
and Mining.
We are also positive on core equity markets such
as French and German equities. We see risks in
UK domestic equities, Swedish and Italian equities.
TRADEIDEAS
Long MCXE versus short SX5E index via futures.
Risk: The risk of buying futures is limited to the notional
invested while risk of selling a future is theoretically
unlimited.
Long worst of (SX7E, SXAP, SXEP) Dec19 105%
call for 2.0% indicatively to position for a cyclical
rebound in equities.
Risk: The risk of buying a worst-of-call is limited to the
premium paid. The option will expire worthless if the
exercise settlement value of the worst-performing
underlying is below the call strike.
Fig. 1: STOXX 600 reporting calendar
Sources: Bloomberg, BNP Paribas
Super-sector/Week of21-Jan28-Jan4-Feb11-Feb18-Feb25-Feb4-Mar11-Mar18-Mar
Banks6%22%29%10%27%5%-1%-
Industrial Goods &
Services6%20%5%19%9%27%10%3%2%
Chemicals5%1%6%26%1%53%3%5%-
Personal & Household
Goods13%29%13%2%13%18%1%7%4%
Health Care1%48%20%10%6%9%5%1%-
Oil & Gas1%23%56%2%2%7%7%1%1%
Insurance1%-21%22%19%7%13%16%-
Technology26%36%13%10%4%9%-1%-
Automobiles & Parts0%6%31%14%5%9%7%13%16%
Telecommunications5%23%5%4%54%6%1%-1%
Food & Beverage-15%9%52%11%11%3%--
Utilities-7%3%3%29%20%3%18%16%
Construction &
Materials4%1%29%1%18%23%14%7%4%
Retail-7%7%21%-29%3%25%8%
SXXP5%21%19%15%14%15%5%5%2%
Ankit Gheedia, CFA, Equity Derivative Strategist, Mathilde Richardot, Equity Derivative Strategist | BNP Paribas London branch
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| FOCUS 16/01/2019 2
Earnings boom versus market gloom
EQUITY & DERIVATIVES
Earnings growth slowdown looms, but we think
investors could be too pessimistic. After eurozone
earnings grew by 17% in 2017, consensus estimates
2018 earnings growth will have been a mere 3%, driven
by a global manufacturing slowdown.
For 2019, BNP Paribas macro model (Figure 2, see link)
suggests 5.4% earnings growth, well below consensus
expectations of a 10% growth for this year. However, we
believe investors could be pricing in an earnings
recession for 2019 below consensus and our model
expectations.
Current equity investor sentiment, as indicated by BNP
Paribas Love Panic index, is at its lowest level since
2016. European equity risk premium is at a historical
high, excluding recession years (Figure 3).Moreover, in
2018, the US saw the largest drop in price earning ratios
since the 1980s, excluding the recession years.
Although we expect a slowdown in 2019, we continue to
expect above trend GDP growth for 2019 and trend GDP
growth for 2020, and think Q4 2018 growth concerns
could reverse in early 2019. We fail to see any significant
balance sheet imbalance in the global economy to drive
the next recession. Central banks still have scope to
change the pace of tightening to avoid an abrupt end to
the cycle.
BNP Paribas economists expect a trade agreement
between the US and China, helping growth, and we don’t
foresee a political crisis in Europe in the short term; on
Brexit, we expect the UK to request an extension of
Article 50 and, most likely, a second referendum.
Despite investor concerns, global equity earnings have
remained healthy. Figure 4 suggests that, although
earnings momentum has slowed, investor concerns on
recession risks could be overdone.
Given the above, we see room for upside during the
upcoming earnings season, and think mid-caps could
outperform large caps (see overleaf).
Fig. 5: Euro STOXX full-year sales and EPS growth, % y/y
Sources: FactSet, BNP Paribas. Estimates are consensus.
Fig. 4: Global equity earnings rising apace
Sources: Bloomberg, BNP Paribas
Fig.2: BNP Paribas macro earnings model for eurozone
Source: BNP Paribas
(4)(3)
(1)(2)
+2
+0
+3+3
(2)(2)
+4
+9
(0)
+17
+3
+10+9
+8
-551520132014201520162017E2018E2019E2020E2021E
SXXE SPS y/y (%)SXXE EPS y/y (%)
40
60
80
100
120
140
160
020406081012141618
MSCI World EPS
Ankit Gheedia, CFA, Equity Derivative Strategist, Mathilde Richardot, Equity Derivative Strategist | BNP Paribas London branch
2%
3%
4%
5%
6%
7%
858891949700030609121518
US ERPEurope ERP
Fig. 3: European equity risk premium at multi year highs
Sources: Bloomberg, BNP Paribas
AssumptionsConsensusInflation shockBull case
Nominal GDP yoy+4.8%-100bps+100bps
Wages yoy+3.1%+50bps+100bps
Input prices yoy+2.4%+50bps+200bps
Buyback %of market cap+1.0%no stressno stress
Effective tax rate+26.0%no stressno stress
ForecastConcensus
Light
upside
scenario
Bearish
scenario
Earnings yoy+5.4%+0.3%+4.2%
| FOCUS 16/01/2019 3
Small is still beautiful: Earnings could boost MXCE
EQUITY & DERIVATIVES
European mid-caps underperformed in Q4 2018: From
September until mid-October, the sharp rise in real yields
in the US and in Europe (Figure 6) saw small and mid-
caps, and growth factor stocks, underperform globally.
Weak growth also put pressure on the European mid-cap
index (MXCE) in Q4 – the eurozone co-incident indicator
fell throughout 2018 (Figure 8).
In H1 2018, the weakness in growth was driven by
weather-related and other one-off factors and, as a result,
the MCXE continued to outperform, but between
November and December, market concerns about global
growth caused the index to underperform.
Geopolitics also weighed on domestic eurozone equity
performancelast year. Risk in Europe remained elevated
for most of H2 2018, driven by Italy and Turkey and
Brexit.
Given our positive view on the domestic eurozone
economy, we think European mid-caps could start to
outperform again in 2019, although we expect returns
to stay in the high single digits. The fundamentals
suggest eurozone mid-caps are currently trading at crisis
level valuations (Figure 7).
The trade agreement we expect between US and China,
would be a key catalyst for European mid-cap
outperformance, in our view.
In the past few days, the BNP Paribas geopolitical risk
index has normalised, coinciding with resumed MCXE
outperformance.
As a result, and all other things remaining equal, we
expect mid-cap stocks to continue to outperform large
cap stocks in Europe in 2019. Investors could consider
going long the MCXE versus short SX5E index via
futures.
Fig. 6: Real yields rose in Q3’2018
Fig. 8: MCXE/SX5E performance correlated to growth
Sources: Bloomberg, BNP Paribas
Fig. 7: Valuations reaching 5-year trough
Sources: Bloomberg, BNP Paribas
Sources: Bloomberg, BNP Paribas
-1.1
-1
-0.9
-0.8
-0.7
-0.6
-0.5
-0.20.2
0.4
0.6
0.8Jan-17Jul-17Jan-18Jul-18Jan-19US Real yieldEU 10Y real yield (%, rhs)
Ankit Gheedia, CFA, Equity Derivative Strategist | BNP Paribas London branch
-0.50.51.5
92
102
112
122
132
142
152
101112131415161718
MCXE / SX5EEuro-coincident growth indicator (rhs)1014180506070809101112131415161718MCXE PE ratio