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Forthcoming Event

There is no pick-up in activity to save what were again misplaced expectations of stronger economic activity. In this respect, 2014 is very similar to 2013 or 2012. The year starts with forecast growth rates for corporate earnings approaching mid teens, though current macroeconomic situation and leading indicators do not allow to entertain such hopes. At mid point into the year, earnings revision momentum nosedives as growth has remained stuck in neutral. Comes September, and it becomes clear to all that no miracle is on its way to salvage what is left of these foolish earnings expectations. Final capitulation...until the start of the following year when the cycle starts again.

Consensus for 2015 calls for an increase in European corporate profits of 13.8%. Brace for more of the same. Should we be concerned about that?

First of all, I hope that investors have learnt from the past and are not willing to take at face value these fanciful predictions regarding earnings growth. Secondly, I think that prospects for next year look marginally better than at any point in time since 2011. The strength of the dollar will help (40 to 50bps positive contribution to GDP if the rate drops to 1.2 according to economists). There will be no more fiscal headwind and even possibly some small scale stimulus in some countries turning their back to Merkel's policies (France and Italy). Credit is easing thanks to Draghi's LTTRO (though appetite for credit appears to be definitely on the low side). The U.S economy seems on track to continue expanding. All in all, this is an improvement over 2014, 2013 and 2012, even if it will not probably be enough to meet sell side analysts' over ambitious forecasts. This is why I am not tempted to chase for the short book the coat tails of this year's negative earnings revision. Next year will come soon enough.

However, two issues are bearing on investors' sentiment. First, deflation is settling in the Euro zone landscape. It could not be otherwise given the policy mix imposed by Angela Merkel on her neighbours, and I do not know why economists were irrationally expecting a rebound post summer for some unknown (at least to me) technical reasons. The bad news is that CPI might just slip under zero fairly soon, given the tumble taken by commodities (oil price down 7%, wheat 13%, copper 5% just in one month). The good news is that this sort of deflation in my modest opinion is good for consumers and therefore for real consumption. The second issue is the exit from super monetary stimulus. QE in the U.S has come to an end. Given that it played an undeniable role behind the asset price inflation of the last 3 years, the end of it cannot be but a net negative for financial markets.

Hopes that QE in Europe would come to the rescue were dented by the lack of any new announcement in Draghi's last press conference. I think these hopes might be misplaced. First of all, I doubt that Draghi thinks that QE can spur growth and rid the euro zone from deflation (he now correctly points at Germany's role in the stagnation of the EZ). He might well be agitating the QE red rag as a threat to force the Germans to reflate to help the rest of the Euro zone. Second, the statutes of the ECB are tying his hands because he would have to buy sovereign bonds proportionately to each country's economic weight. This means that the biggest ticket would be for bunds. What is the point of driving yields from their current level of 0.9% to even lower?

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Lionel Rayon

Lionel joined Schroders as part of the acquisition of Cazenove Capital in the summer of 2013, having been at Cazenove since 2005. He is a senior member of the pan-European equity team and manager of the Schroder ISF* European Alpha Absolute Return (circa $1 Billion AuM). He is also responsible for developing and maintaining a fundamental and valuation screen of European stocks. The screen forms the basis for generating ideas for potential further detailed investigation by the European team within the framework of their disciplined Business Cycle Approach. Lionel joined from Citigroup where he was a Director in the European Tech Research Team. Prior to Citigroup, Lionel had been with Schroders Securities, as a French specialist, Nomura Research Institute, as a metals & mining specialist, Enskilda and Chevreux de Virieu. Lionel graduated from Indiana University (MBA) and Institut d'Etudes Politiques de Paris (BSc economics & finance). He has 20 years of equity research experience.

Website: www.schroders.com

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