Eurozone Confidence, $/Euro Levels, Q2 Earnings Leverage

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Eurozone Confidence, $/Euro Levels, Q2 Earnings Leverage

Three “Data” topics to discuss with you today:

#1: European consumer confidence. As much as the Eurozone and US economies generally track each other over time, European consumer confidence tends to be more volatile. The highs are generally higher, and the lows are often lower. This makes sense: the European economy, which has less technology exposure than the US, is more cyclical so you’d expect to see consumer confidence move around more.

This chart of OECD Consumer Confidence surveys (black line, right axis) and US Consumer Sentiment (Michigan survey, red line/left axis) back to January 2009 shows just how much more volatility there is in the Eurozone data. We’ve indexed the data here, setting the May 2020 lows at 100.

Three things stand out to us in this historical record:

  • While Eurozone consumer confidence rebounded much more quickly than in the US after the Financial Crisis (black line over red, 2010 – 2011), it plummeted again after the Greek Debt Crisis. It would not be until 2015 before it finally caught up to the US readings.
  • The peak for Eurozone consumer confidence came in December 2017, right when it seemed most likely that the world would see a global synchronized expansion in 2018. That was not to be, due to the US-China trade war/higher interest rates, and confidence fell shortly thereafter.
  • Now, Eurozone confidence is moving sharply higher as the area reopens (far right section of the chart). The scale and rate of change looks very much like the post-Financial Crisis move, and even if May’s Michigan survey meets expectations it will not likely best Europe’s rebound.

Takeaway: investing during a global cyclical recovery means finding the areas with the best relative momentum, and at the moment Europe’s consumers are expressing greater incremental confidence than their American counterparts. We continue to like MSCI Europe (IEUR is one ETF that tracks this index) and MSCI UK (EWU) as ways to play this trend.

#2: Tying currency markets into that observation, let’s look at the euro/dollar exchange rate versus Eurozone consumer confidence.

Here is a chart of Confidence (black line, right axis) and euro/dollar value (red line, left axis) back to 2015. As you can see, the correlation is solid over the medium term (6-12 months). Peak confidence (December 2017) lead peak euro by 2 months, and declining confidence coincided with a declining euro/$ exchange rate. Now, improving confidence is running alongside a stronger euro.

The big question at present is “can the euro get back to its $1.25 highs of early 2018?” At $1.21 on Friday, we are certainly close and the ramp in consumer confidence says the Eurozone should have the economic momentum to see those old highs or even surpass them.

Takeaway: a stronger euro is positive for 2 reasons. First, it confirms that markets believe the Eurozone will see a solid recovery from their Pandemic Recession. That’s good for corporate earnings both in Europe and the US. Second, US dollar-based investors see an exchange rate benefit on top of Eurozone equity market performance.

#3: Since we continue to hinge our positive view of US equities on corporate earnings leverage, let’s look at what news Q2 financial reports may bring on that count.

The trick we use to understand where the surprises may come from is to look at expected revenue growth. Big beats on the top line give you the best chance of seeing outsized earnings upside. That is what will force analysts to keep raising their estimates.

Here is the latest FactSet analysis of Wall Street analysts’ expected revenue growth by S&P 500 sector for Q2 2021.

Four points on this data:

  • The spread between slowest and fastest revenue growth by sector is vast. Yes, that’s to be expected given we’re talking about comparisons to last year’s second quarter. But the larger the revenue comp, the harder it is for analysts to accurately estimate contribution margins and, therefore, earnings.
  • Two cyclical groups we like – Energy and Industrials – show well-above S&P 500 levels of expected revenue growth. Consumer Discretionary and Materials, as well as Communication Services, should also show better-than-S&P top line improvements.
  • Worth noting: Comm Services gets its revenue juice this quarter from Google (+46 pct expected sales growth) and Facebook (+60 pct expected sales growth). Expectations that these comps will make for big earnings beats are pushing these stocks higher right now. If you’re looking for a trade into quarter end, these stocks are a reasonable place to look. Their ad-based revenue models make them look more like growth cyclicals than defensive(ish) Big Tech at the moment.
  • A whole swath of the S&P 500, from Tech (+17 pct expected rev growth) down to Financials (+4 pct), are expected to post below-index levels of sales growth. The only group we think is OK to overweight is Financials, as we outlined last week.

Takeaway: any bullish argument for US large caps just now – including ours – assumes that markets have not fully discounted the earnings leverage that will come from incremental revenues in an economic upturn. Cyclicals, with their less-predictable revenues and relatively fixed costs, remain well positioned to show outsized sales growth and therefore upside earnings surprises.