Trailing European Profits Don’t Dull Stock Rally

The Stoxx Europe 600 Index has climbed 8.3 percent in 2012, bringing the rally since last year’s low to 23 percent as the European Central Bank loans record cash to banks at below-market rates. While the gains have matched the Standard & Poor’s 500 Index (SPX), European companies will earn less than ever in 2012 compared with their American counterparts, according to analyst estimates compiled by Bloomberg since 2006.

Bulls say equities in the region are irresistible because Stoxx 600 valuations already reflect prospects of a recession, while Greece reached an agreement for the biggest sovereign-debt restructuring in history and the ECB may lend 470 billion euros ($633 billion) to banks. Bears say share prices have risen too fast and government plans to reduce debt with austerity budgets will cause years of sluggish growth.

“A lot of the negative news in terms of earnings, economic outlook and risks coming from the sovereign problems has been discounted,” said Joost van Leenders, an Amsterdam-based strategist at BNP Paribas Investment Partners, which oversees $662 billion and last week upgraded its allocation to European equities. “Valuations are much lower in Europe than in the U.S.”

Up, Down

The Stoxx 600 slipped 0.4 percent last week to 264.77 as the second bailout for Greece failed to allay investor concerns. The S&P 500 rose 0.3 percent to 1,365.74, the highest level since 2008. The European equity benchmark retreated 0.8 percent and S&P 500 futures expiring next month slid 0.5 percent to 1,356.9 at 12:04 p.m. in London today.

Credit default swaps to insure European government bonds cost more than nine times that of U.S. government securities, a record, up from four times in July, according to CMA, a CME Group Inc. business that compiles prices quoted by dealers in the privately negotiated market.

Siemens AG (SIE), Royal Philips Electronics NV and 109 other Stoxx 600 companies have reported results that missed analysts’ forecasts for net income since Jan. 9, data compiled by Bloomberg show. At 52 percent, more companies have trailed predictions than any quarter since 2006.

European stocks have rallied even as analysts lowered income projections 10 percent since October. Combined profits of companies in the gauge will increase 16 percent to $32.22 a share this year, compared with a 9.7 percent increase in the American index to $104.35 a share, according to estimates compiled by Bloomberg. The ratio between the two income totals rose to 3.3 last month in dollar terms, the biggest in data starting in 2006.

Cutting Projections

Projections for the 30 companies in Germany’s benchmark DAX Index (DAX) slipped 9.7 percent in the same period, while those for Italy’s 40-company FTSE MIB Index plunged 18 percent. The reduction for the Stoxx 600 was 3.5 percentage points greater than the S&P 500’s, the data show.

Stocks are rising even with lower forecasts because “people are more comfortable buying into companies where earnings estimates have been reset to levels where they can only improve,” said Priyanthan Kodeeswaran, who helps oversee about $4 billion at RWC Partners in London. “The big question for Europe is obviously the political side and the potential credit crunch. But we are finding value.”

The Stoxx 600’s price-earnings ratio has expanded 34 percent to 13.4 since its low point in September, compared with the S&P 500’s 22 percent increase since Oct. 3 to 14.1. Both remain more than 10 percent below the average since the bull market began in March 2009, Bloomberg data show.

‘Not Attractive’

“Valuations are not attractive anymore,” and should be 10 percent to 15 percent lower, James Butterfill, who helps oversee $49 billion as a global equity strategist at Coutts & Co. in London, said in a Feb. 23 phone interview. The ECB bailout of banks “certainly puts a floor on equities, but it is probably priced in,” he said.

ECB President Mario Draghi lowered the euro area’s key interest rate twice since November and on Dec. 21 awarded 489 billion euros in loans to 523 banks to keep credit flowing. Financial institutions will ask the ECB for 470 billion euros in three-year funds for allotment on Feb. 29, according to the median of 28 estimates in a Bloomberg News survey.

S&P cut the ratings of nine euro-area nations on Jan. 13, stripping France of the top debt ranking and leaving Germany as the only economy in the region with a stable AAA grade. The yield on 10-year Portuguese bonds rose to a euro-era record of 18.29 percent on Jan. 31. A “sizable” sovereign-debt restructuring is likely in the country over the next 12 to 18 months and more restructuring in Greece is likely, Citigroup Inc.’s chief economist, Willem Buiter, wrote on Feb. 22.

Economist Forecasts

Gross domestic product in the euro area may contract 0.4 percent in 2012 while U.S. growth accelerates to 2.2 percent, according to the median estimate of 25 and 79 economists, respectively, in a Bloomberg survey. The 17 nations sharing the single currency will shrink 0.3 percent in 2012, the European Commission said last week, abandoning a November forecast of 0.5 percent growth, mostly because of projected contractions of 1.3 percent in Italy and 1 percent in Spain.

Neither the prospect of a recession nor worse-than- estimated earnings have kept investors from buying European equities. The Stoxx 600 is up 15 percent since Aug. 24, the last time the median forecast for 2012 growth was higher than 1.5 percent, Bloomberg data show.

Lower Profits

Declining profitability in its four main units pushed results at Munich-based Siemens, Europe’s largest engineering company, below analyst estimates on Jan. 24. Amsterdam-based Philips, the world’s biggest lightbulb maker, said Jan. 30 it’s “cautious” about 2012 after writedowns, sluggish sales and costs to exit a television business led to its biggest loss in a decade. Siemens has gained 1.5 percent this year, and Philips has climbed 1.8 percent since reporting the results.

Essen, Germany-based ThyssenKrupp AG (TKA), the country’s largest steelmaker, posted a first-quarter loss on Feb. 14 after project delays and cost overruns and said it was unable to give a “reliable” outlook given the sovereign-debt crisis. The stock surged 16 percent in 2012.

Legrand SA, the world’s largest maker of wiring devices, reported earnings that missed analyst estimates on Feb. 9 and said its operating margin may fall in 2012 as sales stagnate because of southern Europe’s economic slump. Shares of the Limoges, France-based company have rallied 11 percent this year.

Bank Rally

An index of banks in the Stoxx 600 has risen 15 percent in 2012, even after falling 1.6 percent today. Belgium’s KBC Groep NV (KBC) and Italy’s Banca Popolare di Milano Scarl (PMI) helped lead gains as government bonds in those countries rallied. The banks fell at least 60 percent in 2011.

Commerzbank AG (CBK) has gained 49 percent in 2012. The Frankfurt-based lender announced plans on Feb. 23 that may boost capital by more than 1 billion euros. Banks (SX70) in the Stoxx 600 are trading at 0.7 times book value, compared with the average of 1.5 times since 2002.

“The carcass has now been picked over so thoroughly, I think it’s much less risky,” Barton Biggs, founder of hedge fund Traxis Partners LP in New York, said in a Feb. 23 interview with Bloomberg Television, adding that he bought a basket of Italian stocks this year weighted “heavily” toward banks. “Something gets that cheap, we’re willing to take a shot at it.”


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