Deutsche Bank sees downside risks to European profit forecasts

The earnings drought for European firms may be about to come to an end, but thanks to 'base effects' and not because of strong quarter-on-quarter growth, strategists at Deutsche Bank said.

A rebound in energy sector earnings and a slowdown in earnings downgrades for banks were the chief factors behind the expected improvement in third quarter profits, Sebastian Raedler, Wolf von Rotberg, Thomas Pearce and Andreas Bruckner said in a research note sent to clients.

"Even if earnings were to stay flat at Q2 2016 levels, they would be 7% above Q3 2015 levels," they explained.

Consensus forecasts for European earnings during the next 12 months had "stabilised" recently, after falling by 9% between June 2016 and June 2016, as the price of oil rebounded by 70% and sovereign bond yields began to stabilise in early August, they explained.

Indeed, stronger euro area macro-surprises allowed net earnings revisions to rise to a nine-month high, but risks remained to the downside, the broker added.

On average, analysts were expecting earnings per share to grow by 13% in 2017, which to Deutsche Bank still looked "too high".

Their GDP forecasts led them to pencil in EPS growth of just 4%, leaving a nine percentage point gap versus consensus.

The oil price was no longer pointing to upside for oil EPS and upside to banks' earnings remained limited as long as bond yields remained low, the strategists said.

What's more, they put the odds of an economic recession in the States over the next 12 months at 30%, which would lead to EPS growth falling below -5%.