* Q4 earnings seasons kick off – don't hold your breath
After the PE re-rated by 50% (since mid-12) investors await a rebound in European earnings. The season has kicked off and peaks on 24th February. Q3 saw the weakest Revenues since 2009, but EPS was a bit better. We expect Q4 to be even worse. While only one-sixth of our population has reported (too small to extrapolate) a net 14% have missed on Revenue (again!) and a meagre 3% of companies beat on EPS - the weakest since the Eurozone fell back into Recession mid-2011.
* 4 head-aches: AQR, overall kitchen sinking, a strong Euro & low inflation
4 fears: 1) Banks take large provisions to cover loan, litigation and regulatory risk ahead of the AQR review of 31 Dec balance sheets; 2) as Europe closes off its 3rd year of double digit EPS disappointment non-financials are tempted to clean-up house too ahead of the long-awaited 2014 recovery; 3) EURO DRAG is the biggest in a decade; and 4) Producer price inflation is the worst in 12 years (other than 09) and consumer price inflation struggles to remain at 1%. Not great for nominal profit growth.
* Keep calm and look through Q4 – outlook is key
European earnings are depressed versus history & the US so we see limited downside (barring a full blown EM balance of payments crisis). Why? The disconnect between the PMI / IFO current conditions 'and' earnings is verging on bizarre; the operating leverage expected in 2014 is akin to 2003/04 when profits exploded; and net debt keeps falling further. As we flush out the bad news we open the door to an even better 2014. Watch out for: badly needed revenue growth, a better domestic backdrop (vs EM); FX pain; any sign of bank optimism/lending, increasing capex and M&A (animal spirits).
* Stocks: Beats & Misses and currency checklists (most exposed to EM)
Our analysts see potential for positive surprises for stocks including: BASF, ITV and IAG and negative surprises: Air Liquide and Renault. See pages 14, 17 and 23 onwards.