StockBeat: Downbeat Commission, Results Give Markets a Reality Check

© Reuters.

By Geoffrey Smith 

Investing.com -- The U.S. stock market may be de-anchoring itself from economic reality but the European one is at least trying not to.

Markets across the Continent fell on Tuesday after the European Commission revised down its forecasts for EU gross domestic product both this year and next due to the coronavirus pandemic.

The new estimates show both a deeper contraction and a weaker recovery over the next 18 months. Eurozone gross domestic product is now expected to shrink by 8.7% this year, instead of 7.7%, and to rebound by 6.1% next year, instead of 6.3%.

The regular quarterly update from the Commission is getting more attention than usual because its spring forecasts had essentially been guesswork, having no base of hard data from the lockdown period. That vacuum has now been filled.

No surprise, then, that the Stoxx 600 was down 1.1% at 367.24 by 5:30 AM ET (0900), with the German DAX the big laggard, down 1.4%, having made the smartest recovery since March. The U.K. FTSE 100 was also down 1.3% while the Italian FTSE MIB outperformed, losing only 0.2%.

The DAX’s underperformance is explained partly by the Commission’s bleak outlook for global trade. The ravages of Covid-19 across India and both North and South America will likely stop Europe from taking its traditional path of exporting its way out of a recession. That makes it doubly important that the ECB and eurozone governments continue to support domestic demand with generous wage subsidies and loose monetary policy in the coming months.

“The still rising rate of infections, particularly in the US and emerging markets, has deteriorated the global outlook and is expected to act as a drag on the European economy,” the Commission said.

The new outlook is still hostage to some crucial assumptions, notably, a gradual lifting of containment measures and no major second wave of infections. It also assumes that fiscal and monetary policy will prevent large-scale bankruptcies and layoffs.  

Those assumptions are set to be challenged in the next couple of weeks by what is sure to be a gloom-laden second-quarter earnings season.

The first numbers dribbling in have not inspired much confidence: hotel operator Whitbread (LON:WTB) PLC’s shares fell 4.3% after it reported an 80% drop in revenue in its fiscal first quarter and warned that demand for rooms in key big cities such as London remains “subdued”.  Meanwhile French catering group Sodexo’s shares fell 5.9% after it reported a 30% drop in revenue in its fiscal third quarter – even though it said full-year operating profit will fall by less than the 25% it forecast previously.

Given how long the market has had to process the outlook for such companies, neither update should have been much of a surprise. The sharp drops in the share prices do not bode well for the rest of the season.