Investors will look to the upcoming earnings season to see whether stocks can recover from recent losses or if more declines are ahead. Bond yields have risen over the past three months, bringing down the value of stocks — but the more imminent and real risk is on the earnings front as we enter the third-quarter reporting season, according to Gerry Fowler, head of European equity strategy at UBS. “All year, we’ve seen the steady weakening in European soft data and, more recently, hard data. This is the earning season when we start to worry about margins into 2024,” Fowler told CNBC’s ” Squawk Box Europe ” last week. While Fowler doesn’t expect an immediate sharp decline in earnings, he expects there will be an extended duration of “pain” into 2024. “Margins are still very elevated post-Covid, and our model actually expects a near full reversion of margins back to the average of the last 10 years,” he said. “So, if you take a little bit of sales growth but a lot of margin contraction, you actually get to a number of -17% for earnings next year, and at the moment, the market expects +7%.” Fowler also thinks there will likely be more net misses for earnings for the first time this year after a solid first quarter and a mixed second quarter. He said economic data has not improved since the second quarter, pointing to weak survey and retail sales data. Fears of a euro zone recession have been compounded after HCOB’s flash composite purchasing managers’ index for September came in at 47.1, up from August’s 33-month low of 46.7 but below the 50-mark separating expansion from contraction. Fowler isn’t alone with those concerns. In a note titled “Q3 Earnings – Make or break,” Barclays analysts echoed that sentiment, suggesting that despite resilient earnings thus far, more mixed third-quarter economic indicators hint at equally varied results. “Numbers (particularly for Europe) have been lowered, so the bar is not set high. But expectations from our sector analysts feel more mixed this time, and we doubt earnings season can do much more than help stabilize, with risk skewed to the downside on misses rather than much upside from beats,” said Barclays European equity strategists led by Emmanuel Cau in a note to clients on Oct 11. “Earnings are the last shoe to drop, so if they disappoint, it is hard to see what will be a backstop to the stock market.” How will stocks react to earnings? UBS analysts have identified stocks that could surprise, both positively and negatively, when their earnings results are released in the coming weeks. For upside, Fowler named European lender Santander , industrial giant Atlas Copco and pan-European airline Ryanair . He named Siemens Energy , semiconductor company Nordic Semi and Swedish miner Boliden for downside surprises. Fowler said UBS analysts have historically been pretty accurate at predicting surprises, especially when combined with a value investing bias, which has tended to outperform. Fowler also looked at how institutional investors, such as hedge funds, have positioned themselves in each stock based on prime brokerage data across the industry. Stocks primed for a positive surprise due to overly negative sentiment include Vonovia and Universal Music Group . On the downside, he said crowded names like AstraZeneca could be vulnerable.
