The correction on the global stock markets is probably not yet over, the US presidential election scheduled for November is casting its shadow, and the possible failure of the EU-UK negotiations is unsettling investors. Topic no.1 clearly remains COVID-19.
After the reporting season for Q2, investor interest has returned to economic data. The markets are desperately waiting for indicators that provide reliable information about the extent of the recent increases in new COVID-19 infections and their impact on the economy. This data is essential for corporate earnings estimates, which are in turn aggregated and fed into stock market valuations. The price-earnings ratios of most indices are at record levels and on one hand reflect the reduced profit expectations of market participants in the denominator, but on the other hand reflect hope for an early recovery, which is reflected in the share price.
It is worth taking a closer look at the development of earnings estimates, although the first impression may be somewhat disturbing. Analyst forecasts have been revised significantly downwards over the past twelve months, with the Stoxx 600 Europe recording cuts of 43% for the 2020 fiscal year and around 26% for 2021. Just how difficult it will be for some sectors to recover can be seen by looking at the sub-indices of the Stoxx 600, with four sectors standing out and thus appearing to be the most affected. Unsurprisingly, companies in the travel and leisure industry lead the list, with earnings expectations for 2021 down 72%, leaving the oil and gas (-52%), banking (-43%), and automotive (-41%) sectors far behind.
Interestingly, all four of these seemingly prominent sectors together currently represent less than 13% of the market capitalization of the Stoxx 600. By far the most strongly capitalized sector of the leading European index is Healthcare. The 56 companies in the index already represent almost one-sixth of the Stoxx 600. Healthcare (together with technology and few other industries) is one of the sectors with the most attractive long-term growth prospects. Is this a reason to enter the index right now and invest in European stocks?
We come back to the current valuations, which - due to the still limited visibility - are based on extremely vague assumptions and subsequently on shaky earnings estimates. The P/E ratio of the Stoxx 600 based on profit expectations for the current fiscal year is currently 22x. Even based on the earnings forecasts for 2021, the P/E ratio is still just under 16x, which is also well above the historical average of just over 14x. As usual, the American S&P is valued substantially higher, with P/Es currently reaching record levels of 25.5x (2020) and 20x (2021).
The valuations are high, and apparently anticipate a relatively rapid economic recovery. For the US, we (Erste Group Research) expect a GDP decline of -4.3% this year, in the Eurozone a GDP contraction of -7.6%, which the economies will have to digest first. Visibility is improving only slowly, which is why we expect stock markets to move sideways most likely in 4Q. In our view, only rising profits, or at least the prospect of them, would justify higher share prices. We still have to wait for such a move. Patience is needed, because "Patience is the art of hope" (Luc de Clapiers, Marquis de Vauvenargues).
Christoph Schultes, MBA, CIIA
Erste Group Bank AG
30 September 2020
Wiener Börse AG would explicitly like to point out that the data and calculations given in this report are historic values, which do not permit any conclusions as regards future developments or value stability. Price fluctuations and loss of capital are possible in securities trading. The contribution is the personal opinion of the analyst and does not constitute a financial analysis or a recommendation for investment by the exchange operating company, Wiener Börse AG.