In January, extraordinary events in Europe overshadowed the more profane headlines from the latest earnings season. But the region’s key economic policy parameters have now been reset - and they are, in sum, more supportive of growth than before. Hence, barring a maliciously instigated freak accident with respect to Greece, investors will soon refocus on corporate earnings, which remain strong in the US and Japan, and are promising in Europe.
The past few weeks have brought about remarkable policy shifts. Switzerland abruptly returned to a flexible currency regime and the Eurozone at long last launched a proper, large-scale quantitative easing program. Last but not least, Greece’s election result ultimately underscores that hard austerity as the policy of choice is on the way out in Europe.
Admittedly, there still remains a risk with regards to what happens with Greece - and that is a risk that, if we think it through, might actually go well beyond the question of a Greek euro exit, or “Grexit”. If Athens’ relationship with the West were to deteriorate beyond repair in coming months, Greece would probably not only end up leaving the euro and the European Union, but could also turn its back on the North Atlantic Treaty Organization as well. Before too long, Russia might then finally gain military bases in the Mediterranean.
For the first time since the USSR collapsed in 1990, it would be Russia, not the West, that establishes a strategic foothold within the opposite camp’s territory. In the geopolitical arena, Moscow would then be widely seen as having scored another victory versus a squabbling EU, and a largely absent US. Hence, despite being probably economically manageable, a “Grexit” would raise a number of questions that are all capable of seriously undermining broader confidence in Europe.
So far, however, what matters more is the launch of quantitative easing in the euro area, and the prospect of a much more likely new agreement on Greece - which would in turn confirm a continued shift toward less austerity in Europe. For example, the new Greek government will reportedly propose converting a portion of its debt into bonds whose payments are linked to the growth in Greece’s nominal gross domestic product. Rather than calling for an outright debt write-down, as the electoral campaign suggested, Athens is actually trying is to incentivize its creditors to be more interested in promoting growth, rather than just austerity.
Of course, it may take some time, as well as nerves, until we will actually see a new arrangement on Greece. Meanwhile, however, we can take some comfort in the fact that corporate earnings remain remarkably strong in practically all developed regions.
In the US, where about half of the public companies have reported results for the fourth quarter of 2014, earnings and margins continue to surprise on the upside. Overall, US earnings per share rose about 5% year-on-year, against an initial consensus call for a small decline. In Japan, with 55% of the reports published, EPS continue to grow at a robust pace, while analysts remain perhaps even more conservative on average. Specifically, while Japanese corporate earnings were forecast to stagnate last quarter, they actually rose about 11% - and that number actually understates the situation because it was dragged down by losses at a handful of utilities and one oil company. Excluding these sectors, MSCI Japan EPS surged some 23%, surpassing estimates by 17.5%.
Lastly, Eurozone earnings have just started to trickle in - with only about one firth of the region’s corporate reports published thus far. However, the first indications are positive, as financial sector EPS rebounded, while the energy and materials sectors weren’t hurt as badly as the analyst consensus had feared (the same is true for the US, incidentally). With the European Central Bank’s QE set to start in March, and the euro at much more attractively valued levels than a year ago, it is not hard to see why Eurozone earnings should not finally start meeting - or even surpassing - the elevated expectations for an admittedly belated, but nevertheless strong rebound.
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Note: The next LGT Beacon will be published on 11 February 2015.