Weekly Update - Equity markets: the earning season shows why we prefer the US to Europe
The United States economy grew strongly in Q3, in sharp contrast with the euro area’s GDP growth contraction. Corporate results tell a similar story, in turn helping explain why US stock markets have outperformed their European peers by more than 1.5 times year to date, gaining around 15% compared to 9%. True, US stocks may look expensive and their European peers more attractive, particularly on 12-month forward price-to-earning ratio. Nevertheless, we think the US market will continue to outperform as long as the growth gap favours the United States.
Healthy growth in the United States, sluggish in Europe. The most striking illustration of the yawning gap between US and European economies is their respective economic growth rates. The United States expanded at an annualised rate of nearly 5% in Q3 2023 (1.2% quarter-on-quarter). In the same period the euro area economy shrank by 0.4% annualised (-0.1% quarter-on-quarter).
Data for Q4, mainly business sentiment surveys, point to a slowdown in the US and hence suggest some convergence between the two countries. But the US still has a better growth momentum. Consensus growth forecasts show the US easily outstripping Europe at full-year 2023, with growth of 2.3% compared to 0.5%, and outperforming again in 2024, with 1.0% vs. 0.7%.
Company fundamentals are solid in the United States and pretty good in Europe. The strong growth of the US economy has boosted companies’ volume sales and helped keep profit margins at historical highs. But this is not the only reason American firms are doing well. Many firms are financed at fixed-rate borrowings at long maturities, insulating their margins against recent rate hikes, for the moment. In Europe, while lower, margins have also been sustained at historical highs as firms have used the cover provided by inflation to raise their selling prices (greedflation), at least in some sectors.
Positive earning season in the US but generally disappointing in Europe. Small wonder, then, that the Q3 results season shows US listed companies to be on a better track than their European counterparts. Earnings per share have continued to grow at a modest 2.5% year-on-year in the United States but have slumped by 13.5% in Europe. That said, the drop in European earnings is largely down to a few underperforming sectors – commodities, industrial, energy and utilities sectors saw profits plummet by 25% to 55%.
What is more, of the 90% of US firms to report so far, more than 80% beat the consensus’ earnings per share estimates, a strong performance repeated across all sectors. In contrast, in Europe, where 84% of firms have now reported, the story is more mixed. Barely half beat their earnings estimates while as many firms surprised negatively as positively in terms of sales (39%). These figures tend to reinforce our equity positioning: globally Neutral with a preference for US markets.
In the highlights of the week, we chose to talk about recent Chinese and US commarcial balances, the return of deflation in China and the continued decline in oil prices.