Unusual European earnings pessimism leaves room for a nice surprise

By Alistair Smout

LONDON (Reuters) - Analysts are unusually pessimistic about 2016 earnings as the first-quarter results season gets into gear in Europe, a situation which may actually end up supporting stocks if the global growth outlook is not as bad as feared.

Market turmoil and concerns over economic activity in the first quarter put the frighteners on European stock market analysts, who have already revised away hopes for double-digit earnings growth in 2016.

For each of the last five years, analysts have been overly optimistic about earnings for the full-year when heading into the first quarter earnings season, leaving the market disappointed when the downgrades eventually come through in the second half of the year, as this graphic shows: http://link.reuters.com/ned35v.

However, Q1 has seen analysts slash forecasts at a rate not seen since the financial crisis. That leaves room for earnings to surprise the market positively for once, and it could prove a support to the market, even if the actual first quarter results are as grim as expected.

"There has been a pretty dramatic capitulation from the consensus of analysts ... After the last five years of disappointment in terms of earnings estimates, analysts have moved earlier and they would hope that they are slightly ahead of the curve, unlike in the past," said Dennis Jose, European equity strategist at Barclays.

"All of that seems a bit too pessimistic to us, especially if our economists are right and we're not heading into a global recession."

First quarter earnings are expected to decline 18.6 percent from Q1 2015, with much of the drag coming from oil and gas firms after a slump in crude prices to their lowest levels in more than a decade. Even if one excludes the energy sector, earnings are still expected to decline 11.7 percent.

However, some analysts are taking heart from the experience of companies such as BP , which had earnings on Tuesday.

It rose 3 percent as it beat earnings estimates, even as it recorded a 80 percent drop in profit.

It said it would cut costs further in order to support profits, a trend that analysts said would support earnings throughout Europe this year, in addition to improving revenue.

"DOWNGRADES HAVE GONE TOO FAR"

"European earnings should still be improving because of a modest, moderate improvement in top-line sales growth, and very strong cost-control," said Andrew Milligan, global market strategist at Standard Life Investments.

The expectation that European companies may manage earnings growth in 2016 after all is underpinned by the market's recovery since a rough first six weeks of the year.

Commodity stocks have actually outperformed in 2016, despite hitting multi-year lows in February, and concerns over the strength of China's growth have been ameliorated by better data there.

Nick Nelson, European equity strategist at UBS, said February saw the most aggressive downgrades to full-year earnings expectations for seven years.

"The downgrades correlated with concerns over global growth. It’s no coincidence that analysts were downgrading the most when the market stress was at its peak," said Nelson.

"We feel the downgrades have gone too far. We take a contrarian view that European stocks might be able to manage around 8 percent earnings growth, while consensus is pricing in low single digit growth, or no growth at all."

If European corporates are going to manage earnings growth, then the first quarter will have to be endured, even if positive surprises from a low level of expectation are possible.

Analysts are already looking to the second half of the year for signs of improvement, and for the recovery in markets, commodities and global economic prospects to filter through.

"Markets will have to be braced for a weak first quarter, and we expect to see improvement come through in the second half of the year," UBS' Nelson said.

"Investors may focus on comments by companies this earnings season, and see whether they see stabilisation in trading conditions. That might matter more than the first quarter numbers themselves."

While some investors are hoping that their hopes for single-digit earnings growth will lend support to markets that are braced for no earnings growth, there is still an abundance of caution about the fundamental state of a world economy that is still battling with inflation and low nominal growth.

"Even if we are talking about a recovery from the weakness in the first quarter, and positive growth for the whole of 2016, this is a world of low numbers," said Milligan at Standard Life Investments.

"In terms of corporate earnings, there is potential for some upside, it's just not going to be double-digit upside."

(Reporting by Alistair Smout; Editing by Sudip Kar-Gupta and Andrew Heavens)