Energy and Basic Resources were clearly the 2005 stories! Energy sector earnings growth expectations for Europe rose from -3% to 45%, accounting for an astonishing 50% of the incremental aggregate earnings.
The other sectors that significantly outperformed in Europe in terms of profitability are chemicals, which benefited from the increase in oil prices, autos which recovered from a low base, and Healthcare which was a value play. There is little surprise in terms of the underperformers which are food & beverage, personal household and retail sectors.
Source: FactSet Estimates
2006 and Beyond
2006 growth rates are slipping from 10% to 8.5% primarily due to downgrades in telecoms and weak retail spending. We expect 2006 earnings to post a more normal single-digit growth. Very similar to the US excluding the base effect from their recent natural disasters Healthcare, Oils and Insurance look initially strong for 2006. In terms of the uplift in the 2006 aggregate earnings most of it again is built upon the surge in energy profits.
Question: Can energy continue to spiral upwards? The revision rates are increasing at a decreasing rate, and oil prices are easing.
Conclusion
Our recommendation to overweight Europe dates back to 2004 (low long-term interest rates, valuation, dividend yields and consistent earnings growth). From that period reforms have occurred to standardise Return on Equity (Return on investment) across both sides of the Atlantic. What remains a question is that the Price-earnings differential remains. Consequently for fundamental investors we continue to favour Europe overweight vs. the US for 2006.
However in the short-term an investor may want to take advantage of the decreasing of rate hikes in the US and play the growth sectors. 2006 will again be overwhelmed by perceptions of geopolitical risks but more so by domestic finance which could drive the commodity markets (safe havens) and energy further. We are reluctant to continue to be optimistic on energy however if this occurs then energy stocks will have another fabulous year. Already eps growth rates have been upgraded from -1% to 3.4% for 2006. Initially Techs, and Telecoms look optimistic for 2006, however consumer staples growth rates look high considering the current environment. Overall we expect a fairly flat market producing a return between 5-7% for 2006.
These views are independent of FactSet Ltd and are proprietary to Bobby Rakhit. For the full report and individual sector reviews and recommendations please contact rakhitreport@yahoo.co.uk.
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