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Investors warn of looming downgrades to US and European earnings forecasts

Expectations for US and European corporate profits have not been fully adjusted to take into account the worsening economic outlook, according to a clutch of investors who warned earnings season could be a disappointment.

Analysts estimate companies listed on Wall Street’s S&P 500 will report 6 percent year-on-year earnings growth for the second quarter, according to a survey by data providers IBES and Refinitiv. The rate of growth is forecast to rise to 11 percent for the third quarter of the year.

Forecasts for Europe’s Stoxx 600 share index are even rosier, with analysts overall predicting 22 percent earnings growth for the second quarter — in part because of the gauge’s heavier weighting of energy companies. In the third quarter, the growth rate is expected to increase to 29 percent.

Some investors are skeptical about those projections, pointing out the mismatch between the progress that companies have guided analysts to expect and a macroeconomic picture, clouded by soaring inflation and business surveys, which suggest the US and Europe are heading into recession.

“We’re going to be seeing earnings downgrades, no doubt about that,” said Neil Birrell, chief investment officer at asset manager Premier Milton Investors. The consensus of analysts’ estimates, Birrell added, “looks like they are in cloud cuckoo land.”

Grace Peters, head of European equity strategy at JPMorgan’s private bank, added that corporate management teams will probably “start to admit” business conditions are deteriorating as the latest earnings season gets under way.

Purchasing managers’ indices, which collate executives’ responses to survey questions on topics such as business volumes and new orders and tend to predict how analysts’ expectations will move, have been pointing south. A PMI for the global manufacturing sector, produced by JPMorgan and S&P Global, hit a 22-month low in June.

“Usually when business confidence drops, analysts downgrade [earnings forecasts] and they haven’t been doing that as much as you’d normally expect,” said Trevor Greetham, head of multi-asset at Royal London Asset Management.

The FTSE All World index of developed and emerging market shares has fallen more than a fifth so far in 2022, with the S&P 500 down by the same amount and Europe’s Stoxx 600 off 16 percent. But some investment strategists say the likelihood of earnings downgrades is not fully priced into stock markets yet.

US equities are the “most vulnerable to earnings disappointment,” strategist at Oxford Economics wrote in a research note. “Margins are stretched [and] cost pressures are broad based,” they wrote.

US financial companies Morgan Stanley, JPMorgan and BlackRock kicked off the Wall Street quarterly earnings season by missing analysts’ forecasts.

Emmanuel Cau, Barclays’ head of European equity strategy, expects the Stoxx 600 to fall to about 380 points, from around 410 currently, if economic conditions unfold as the bank predicts and Russia cuts gas supplies in retaliation for Western support of Ukraine.

“Europe will be in a recession by the turn of the year,” Cau said, predicting that the consensus of analysts’ forecasts for 2023 will gradually change from 5 percent earnings growth currently to a 5 percent decline.

“At face value, equities are cheaper than they were six months ago,” Cau said. “But they are trading on earnings expectations that are too high. The valuations are misleading.”

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