Graham Secker: A Curious Case of Price Movements

Third quarter earnings are heading into the home stretch in Europe and the UK, but while a solid number of companies have beat earnings estimates, market reaction has been a bit curious.

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Welcome to Thoughts on the Market. I'm Graham Secker, Head of Morgan Stanley's European and UK Equity Strategy Team. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the emerging read on third quarter earnings for the region. It's Tuesday, November the 9th at 3pm in London.

Europe and the UK are now more than halfway through third quarter earnings season, and so we're far enough along to form a view on how this quarter's earnings are playing out. And while earnings have been largely solid, price movements on the day of earnings announcements, and in the days following, have been a bit curious. But I'll get into that in a moment.

As it stands, third quarter earnings appear on track to deliver a solid number of companies beating earnings per share estimates. As of yesterday, 55% of European companies have beaten earnings estimates, while 23% have missed, leaving a 'net beat' of 32%, which is twice the historic average. If this holds, it would put third quarter results on track to deliver another strong upside surprise, albeit slightly below the pace seen over the last few quarters. Taking it to the sector level, we find that the strongest breadth of earnings beats are coming from Financials and Energy. On the flip side, Communication Services, Healthcare and Industrials have delivered the smallest breadth of beats so far.

In addition to a healthy number of companies exceeding estimates, we are also seeing a beat in terms of the aggregate amount of European earnings overall, with weighted earnings per share currently beating consensus by about 10% for this quarter. This good news on earnings has driven a fresh bout of upgrades, which should reduce investor concerns around the risk to corporate profitability from ongoing supply chain issues and high input cost inflation.

All that said, earlier, I mentioned a bit of curiosity about price reaction. Typically, if a company beats earnings per share estimates, you might expect to see better stock performance that day or in the days that follow. And of course, the opposite is true for companies who miss estimates. However, a key talking point during this results season has been the surprisingly disappointing price action, even for companies who beat expectations.

Currently, the gap between the outperformance of earnings beats on the day of results relative to the underperformance from earnings misses has been very negatively skewed in a historic context. In fact, this negative skew to price action is close to a record low going back to 2007. On our data, we calculate that EPS misses have, on average, underperformed by 1.6% on the day of results, whereas companies that beat estimates have been broadly flat in relative terms. Hence, while the third quarter has been a solid earnings season overall, the hurdle rate to positively surprise the market is currently quite high.

In our opinion, this reflects investors' uncertainty about the future earnings outlook and whether company margins will face a delayed hit in the quarters ahead. While understandable, we think this caution is overdone. Rather, we expect Europe's earnings dynamic to remain positive into 2022, with companies benefiting from a strong external demand environment and a record level of pricing power.

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