Earnings onslaught offers reality check April 20, 2008 10:29 AM ET
LONDON (Reuters) - Remarkably resilient morale among euro zone investors and businesses will face a reality check this week as first-quarter earnings reports from the non-financial sector get into full swing.
Investors will also get insights into the state of the euro zone's business and consumer sentiment and of its manufacturing and services sectors this week, while UK authorities could reveal details of a plan to break a lending squeeze gripping the home loan market.
World stocks on a MSCI measure have added more than 2 percent over the past week as first quarter results so far have shown firms escaping their worst case scenarios.
Even banks -- the epicenter of the eight-month-old credit crisis -- have come out better than expected, and investors have cheered the sector's efforts to normalize balance sheets and raise capital.
"We've had a mixed bag of earnings but so far they are coming in okay. The concern is more about the outlook and earnings for the remainder of the year," said Philipp Baertschi, strategist at Swiss wealth manager Sarasin in Zurich.
He said the U.S. economic slowdown will sooner or later affect corporates outside the financial sector and darken so far upbeat business and consumer sentiment, especially in Germany.
"Earnings estimates will have to be revised downward... Although the credit crisis has now reached the halfway mark, the effects of recession have yet to feed through to figures in the non-financial sector," Baertschi said.
Major firms reporting Q1 results this week include Boeing , Yahoo , Novartis and Nestle .
The Ifo institute publishes its closely-watched German business climate index on Thursday while Italy's consumer and business confidence data, the French business climate index and the leading indicator in Belgium are also due.
Flash estimates of the euro zone purchasing managers indexes due on Wednesday will show how the region's manufacturing and services industries are coping with the effect of high oil prices and a soaring euro.
DOWNWARD EARNINGS SURPRISES
Many strategists warn investors to be cautious about expecting the positive earnings surprises in the past couple of weeks to continue this week and next.
Credit Suisse, which expects a hard landing for the U.S. economy, says earnings could fall some 20 percent from those already reported and there is a 30 percent downside to market expectations of earnings in 12 months' time.
It also says that during the last three recessions, the average decline in real earnings per share (EPS) has been 21 percent. Real EPS has fallen 12 percent since August.
"Earnings momentum is still very poor. Although the market tends to bottom just before the trough in earnings momentum, it would be improbable in a recession that the trough in earnings momentum is occurring now," Credit Suisse said in a note.
"The first phase of the bear market was corporate credit related; now it is earnings related."
LIBOR STORM
In contrast to stock markets which have managed a decent performance since the beginning of the month, stress is building up again on London interbank lending markets -- this time stemming from doubts over the credibility of reference rates.
On Friday, the London interbank offered rate for three-month dollars hit a five-week high of 2.90750 percent , rising by its biggest daily amount since August as concerns grew that Libor quotes had been understated.
Libor reference rates are used by banks in lending unsecured funds to each other and prices of a wide range of financial instruments are based on these rates.
In recent months, critics have raised concerns that Libor rates come from a small group of banks and do not accurately reflect lending rates, especially in times of stress. There has been also talk that some banks have understated their quotes to mask their appetite for cash.
The spread on two-year U.S. interest rate swaps widened sharply on Wednesday to their widest level in about five weeks as a result of these concerns. The British Bankers Association said it had accelerated a review of its Libor setting process.
Since the credit crisis broke in August, a gap between Libor rates and Overnight Index Swaps -- a short-term benchmark rate for secured funds -- has widened to more than 100 basis points.
Analysts say Britain's plan to rescue the battered mortgage market, which is expected to allow banks to temporarily swap mortgage-backed securities for government bonds, could help ease strains in the short term.
"This is another positive step in the crisis but it also shows that we are not out of the woods yet," Nathalie Fillet, interest rate strategist at BNP Paribas, said in a note.
"The crisis will take time to be sorted out and the best central banks can do is to ease the pain for commercial banks but not make it disappear."
Elsewhere, official interest rate decisions will highlight the difficulties of balancing the dangers of slowing growth against rising inflation threats from surging oil and food prices.
Sweden's and New Zealand's central banks are expected to keep interest rates on hold, while the Bank of Canada is likely to cut rates and Norway's central bank is forecast to raise the cost of borrowing.
(Editing by Ruth Pitchford)
Copyright 2008 Reuters
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