By Thyagaraju Adinarayan and Joice Alves
LONDON (Reuters) - With markets taking fright again this week over trade tariffs and a faltering global economy, investors are braced for weak third quarter results in Europe and high expectations going forward could come crashing down to earth.
There have been a slew of profit warnings in recent weeks which have stirred worries that the earnings slowdown will spill over into next year as companies grapple with weaker economic growth stemming from trade spats and the uncertainty caused by the UK's delayed exit from the European Union.
Markets were rattled this week by U.S. manufacturing and services data that fell below expectations, a move by Washington to hit European products with tariffs and worries over Brexit.
It could be the worst week in a year for the pan European STOXX 600 (STOXX) while the euro-zone benchmark (STOXXE) is heading for its biggest weekly fall in two months.
After falling into a so-called corporate recession in the second quarter after two straight quarters of profit decline, European companies are expected to report in the coming weeks a 2.2% drop in profits in the third quarter, their worst quarter in three years, according to Refinitiv I/B/E/S.
While 4% earnings growth is seen as achievable for the United States in the fourth-quarter, interviews with investors, analysts and strategists and companies paint a different picture for Europe for the remaining months of 2019 and into next year.
For a graphic on U.S. versus Europe earnings growth:
https://fingfx.thomsonreuters.com/gfx/buzzifr/14/7815/7815/Pasted%20Image.jpg
Companies are taking measures such as cutting costs to shore up profits, but a harder-to-fix drop in demand for products is expected to be evident in company revenues for the July-September quarter, which are seen falling 0.3%, the first quarterly turnover drop since early 2018.
There is room for much disappointment given that consensus profit estimates for the fourth quarter and 2020 are still high at around 10% growth and analysts say expectations could be brought back down to reality over the coming months.
"The big hurdle for this year would be the fourth quarter, not the third quarter," said Fabio Di Giansante, head of large-cap European equities at Europe's top asset manager Amundi with 1.43 trillion euros ($1.6 trillion) in assets under management.
"I would expect more warnings after last week," Di Giansante said, following the earnings downgrades by Pearson (L:PSON), Imperial Brands (L:IMB), British Airways-owner IAG (L:ICAG) and Carnival Corp (N:CCL) that knocked billions of pounds off their market value.
At best, Di Giansante expects profit growth to flatline in 2020 while UBS has pegged a 4% drop.
For a graphic on Earnings downgrades:
https://fingfx.thomsonreuters.com/gfx/buzzifr/14/7529/7529/Pasted%20Image.jpg
ROTATION INTO VALUE
A shift by investors into beaten-down stocks that look value for money in September has caught some investors off-guard, who were heavily invested in momentum stocks - rapidly expanding companies - but ahead of the results season value stocks are likely to be seen as a shelter, giving less of a shock if a company misses estimates.
MSCI global basket of value stocks rose 4%, while the momentum stocks slipped 1% last month. Before the rotation, momentum stocks had surged 20% as of August-end, while value stocks were up just 7%.
Di Giansante is among those that have sought safety in cheaper stocks.
"In a normal world, if you're cheap and you miss, in theory you should have more downside protection, but that hasn't been the case in the last year-and-a-half," he added.
For these stocks, "you need to see an inflection point around the corner, if you keep missing, it is postponed".
DEJA VU?
The final quarter of 2018 also started with major stock indexes close to current levels and earnings growth expectations for the year ahead around 10%.
For a graphic on 2020 earnings growth:
https://fingfx.thomsonreuters.com/gfx/buzzifr/14/7528/7528/Pasted%20Image.jpg
Analysts ended up slashing earnings growth estimates for 2019 to low single digits and the toxic mix of an uncertain macro environment and earnings downgrades led to one of the steepest sell offs in stock market history in late 2018.
But this time could be different, some market experts said, as central banks are more dovish now, providing monetary stimulus and interest rate cuts that have supported stock markets.
Equity strategists do not expect 2020 earnings to be as bad as 2019.
"You start with 10% ... the question is not where you start, but where you're going to end up," Edmund Shing, global head of equity derivates strategy at BNP Paribas (PA:BNPP) said. He expects earnings to rise 6% next year.
Aside from the battering stocks received last week, the STOXX 600 index remains on track for its best annual performance in six years.