Earnings boost to help German shares overtake peripheral peers

Reuters - UK Focus

* German stocks set to see earnings growth

* Top (Taiwan OTC: 8419.TWO - news) analysts see continued disappointment in periphery

* DAX better geared to benefit from economic growth

* Light (Other OTC: LGSXY - news) fund positioning in the DAX leaves room for pick-up

By Alistair Smout

LONDON, April 23 (Reuters) - German shares may overtake their Italian and Spanish peers as Europe's star performers this quarter, boosted by better corporate earnings at a time when expensive valuations are making investors more selective.

German companies are seen beating consensus predictions with their first quarter earnings while numbers from firms in Italy and Spain are set to fall short of expectations, according to estimates from the most accurate analysts aggregated by Thomson Reuters StarMine.

This sets the scene for German shares to take the lead after lagging Italian and Spanish indexes since 2012 during a rally that boosted stocks in the euro zone's most vulnerable economies ahead of perceived "safe havens".

Wednesday's expectation-beating PMI survey data was the latest indication that economic momentum in the euro zone's biggest economy remains strong, yet Germany's blue chip index has been a notable underperformer so far this year.

The growing economy has left German stocks well placed to beat earnings expectations in a year during which investors are looking for profits to rebound to support elevated prices. Valuations across Europe are at their highest since 2005.

At the same time, the rally in the periphery has left German stocks relatively under-owned by funds, despite the country's heavy weighting in stocks that are sensitive to the economic cycle and so should benefit most from the recovery.

"Germany has got the better macro-momentum right now than the periphery, and it's also got the situation where you've got more cyclical exposure within the stock market," said Nick Nelson, European equity strategist at UBS (Xetra: UB0BL6 - news) .

"Broadly the message from us is that it's now all about earnings growth being delivered to the market, and we're preferring the more cyclical parts of the market."

Half of the DAX is composed of growth-sensitive or "cyclical" stocks such as industrial, consumer discretionary and financial companies, while defensive shares such telecoms and utilities are among the index's smallest weightings.

Industrial blue-chip companies in Germany are set to beat consensus forecasts by 11.7 percent this quarter, according to analysts with the best track record for accuracy, who say Siemens will be a stand-out. Their predictions for the stock are ahead of average estimates by 14.6 percent.

These analysts estimate that earnings for the DAX grew 8.6 percent year-on-year in the first quarter, 0.2 percent above consensus estimates, Thomson Reuters StarMine data showed.

That compares favourably with the DJ STOXX Europe 600 , where top analysts see profits missing consensus by 0.6 percent, and with Italian and Spanish stocks, where earnings are set to miss forecasts by 2.3 percent and 1.1 percent respectively.


Peripheral euro zone banks are seen missing consensus forecasts by the biggest margin, as money supply data remains weak despite a double-digit rally over the last year.

Profits at Italian banks will lag consensus forecasts by as much as 5.7 percent, the top-rated analysts said.

"The periphery rally has gone too far, given the earnings reality we're about to be faced with," Shore Capital equity strategist Gerard Lane said. "The economic outlook has not got any better, because lending in the periphery is still falling."

Lending by Spanish banks fell again in February, the Bank of Spain said on Monday, while the number of non-performing loans in Italy and Spain remains stubbornly high.

Despite this, Italy's bank-heavy FTSE MIB has pushed on 15 percent this year, compared to a flat year for the DAX, with peripheral stocks supported by a drop in sovereign bond yields to multi-year lows.

The sharp contraction in yields means there may be little room for further gains based on moves in the debt market, with UBS's Nelson saying the focus was now on earnings delivery.

The popularity of peripheral stocks has fuelled fund flows into Europe, with the latest Bank of America (TLO: BAC.TI - news) /Merrill Lynch fund manager survey showing Europe retained its position as the most preferred region for the eighth month running.

Funds invested in euro zone equities have seen a net $4.7 billion of inflows so far in 2014, while Spanish equity funds have attracted $3.2 billion and Italian equity funds $1.8 billion, Lipper data shows. German funds have seen outflows of $9.9 billion, however, leaving scope for a rebound there.

"Germany looks promising after a sharp drop in holdings recently," strategists at HSBC write in a note. "The extent of this selling is unusual and makes Germany an interesting contrarian idea."

(Graphic by Vincent Flasseur; Editing by Francesco Canepa and Catherine Evans)