Stocks are getting cheap, but earnings look shaky

Earnings downgrades are ‘matter of when, not if’, analysts say

Current earnings estimates, particularly in Europe, “continue to defy gravity”. Photograph: Getty Images/iStock
Current earnings estimates, particularly in Europe, “continue to defy gravity”. Photograph: Getty Images/iStock

Heavy market falls mean European valuations are encouraging, but earnings risk is high. So says Barclays, arguing that forward price-earnings ratios are “more reasonable now” and that “a lot is in the price”.

All big markets are trading below their long-term valuation norms. This is especially true of Europe, which is 21 per cent below its 10-year median.

That’s the good news. The bad news: stocks may struggle to bottom until earnings are reset lower.

Current estimates “continue to defy gravity”, with analysts estimating European earnings will grow 14 per cent (up from 6 per cent in January), mainly thanks to soaring commodity profits. However, earnings downgrades are “a matter of when, not if”. The real question is the extent of the downgrades.

A mild recession is priced in. Further downside is limited if a deep recession is avoided, but stocks could fall another 10-15 per cent if we get a deep recession.

Markets are forward-looking, usually bottoming well in advance of the actual earnings trough. Still, earnings remain at peak levels. As a result, a “clear bottom” and sustainable rebound may prove elusive until 2023 expectations start to look more reasonable.

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Proinsias O'Mahony

Proinsias O'Mahony

Proinsias O’Mahony, a contributor to The Irish Times, writes the weekly Stocktake column