Investors brace for European hit on earnings

Investors brace for European hit on earnings

Stock Market Predictions

NEW YORK (Global Markets) - Investors are about to find out if the economic woes in Europe are going to deliver a deep wound to U.S. company earnings instead of the mere scratch that many expect.

The fourth-quarter reporting period kicks off next week, and all eyes will be on erosion in sales in Europe, where the debt crisis has propelled the region toward a recession. This could dent positive sentiment just as investors start to focus on strong U.S. growth.

Analysts believe that low U.S. stock market valuations already factor in weakness from Europe for the fourth quarter, but there are concerns that earnings forecasts for 2012 have yet to account for deeper fallout.

"There's some unhealthy optimism that thinks somehow the U.S. can decouple from the rest of the world," said Shawn Hackett, president at Hackett Financial Advisors in Boynton Beach, Florida. "That is highly unlikely."

Companies including tech heavyweights Texas Instruments and Hewlett Packard and others like insurer MetLife have already cited fallout from Europe for reduced expectations. Analyst forecasts for fourth- and even first-quarter earnings have tumbled since the summer despite steady improvement in U.S. economic demand.

While all 10 S&P 500 sectors have seen profit estimates cut,

materials and financials have been the hardest hit. Other sectors that could get dragged down by Europe's problems include the industrial, consumer and technology sectors.

The overall S&P 500 forecast for fourth-quarter earnings growth has already been slashed, down to growth of 7.9 percent from 17.6 percent previously.

EUROPE'S STRUGGLE

Some 14 percent of all Standard & Poor's 500 company sales come from Europe, which would have a sure impact on results, said Standard & Poor's earnings analyst Howard Silverblatt.

"In earnings, when you're talking about pennies beating it or not, 14 percent of the number makes a difference."

The euro zone debt crisis has engulfed much of the continent as major institutions have found themselves exposed to debts in struggling nations such as Greece, Portugal, Italy and Spain. The latter two are the third- and fourth-largest economies in the euro zone and are struggling to reduce debt through severe spending cuts and higher taxes.

These problems are affecting economic growth. Italy grew just 0.2 percent in the third quarter from the previous year. Economists in a December Global Markets poll forecast the euro zone will contract by 0.3 percent in the fourth quarter, followed by a further 0.2 percent contraction in January-March, before a meager recovery in subsequent quarters.

Global companies with more than 50 percent of their sales in Europe and with a market cap greater than $5 billion underperformed other major averages in 2011, according to Thomson Global Markets data.

An index of 161 names meeting that criteria lost 13 percent in 2011, compared with a 5 percent drop for the MSCI World Index. Cisco Systems, which gets 56 percent of sales from Europe, is the largest U.S. name in this group.

Many other U.S. companies have less exposure to Europe than Cisco, but still generate a substantial portion of their sales - 20 to 30 percent - there. In these cases, it would take a more severe recession to hurt their revenues.

In a report on Thursday examining a number of industrial equipment companies, Morgan Stanley analysts pointed out that many executives were "cautiously optimistic" with expectations for a mild recession in Europe. Companies in that industry are expecting 4 to 6 percent revenue growth in 2012, but Morgan Stanley said "short-term trends" suggest estimates could fall short of that if world growth slows.

Companies including Dover Corp and Illinois Tool Works would be hurt, they wrote. Dow component 3M would also be hit in a "deep recession" in Europe.

"If we're dealing with organic revenue growth, you're going to be seeing earnings declines," said Hackett.

"In some cases, in the more cyclical businesses, it could be very severe, and I do not believe the stock market has priced in what the likely reality is."

Google's stock on Thursday was downgraded by brokerage Benchmark Co, whose analysts expect Google to suffer a decline in European advertising revenue.

PROFITS EYED FOR REBOUND

A drumbeat of negative preannouncements is also raising some concerns.

The ratio of negative to positive preannouncements over the last four weeks is at 3.3, and it hit a 10-year high late in December. The long-term average is 2.3, according to Thomson Global Markets data.

"The number of companies issuing negative guidance during the fourth quarter has increased, and this perhaps has flown a little under the radar screen over the last few weeks in our judgment," Morgan Stanley analysts wrote in a 2012 outlook. The firm expects the S&P 500 to end 2012 at 1,167, which would be an 8.8 percent decline from the current level.

The euro zone's weakness has another detrimental effect. Strength in the dollar against the euro will increase headwinds for earnings, because it makes U.S. goods more expensive in Europe.

"Each 1 percent appreciation in the U.S. dollar corresponds to an expected 0.97 percent decline in aggregate earnings," Morgan Stanley wrote.

Still, many stock strategists are hoping healthy sales from the United States, where the economy is slowly improving, will more than offset the negative impact of Europe.

"Europe is clearly the caboose on the train...(but) I don't think the caboose is as bad as most people think it is," said Ken Fisher, a billionaire investor whose money management firm oversees $40 billion in assets.

"At a time when people have been fearful of a weak Europe, the economy in America has been consistently stronger than people have though it would be," he added.

Several blue-chip companies with heavy exposure to Europe performed well in 2011. McDonald's, for instance, derives 42 percent of its sales from Europe, and it was the Dow's best performer last year, rising 31 percent.

Kraft Foods generates 32 percent of sales in Europe, and its stock rose 19 percent in 2011. And Apple gets 26 percent, according to Thomson Global Markets data, and its stock was up 25.6 percent.

Those gains would be in danger if Europe's fundamentals worsen.

Big-cap multinationals have "become a bit of a darling here in the last couple of months...they're probably more vulnerable to disappointments," said James Dailey, portfolio manager of TEAM Asset Strategy Fund in Harrisburg, Pennsylvania.

(Reporting By Caroline Valetkevitch; Editing by Leslie Adler)

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Analysis:Despite crunch, BNY Mellon is a stock-option contrarian

Analysis:Despite crunch, BNY Mellon is a stock-option contrarian

Stock Market Predictions

BOSTON (Global Markets) - BNY Mellon Corp (BK.N) is sticking with employee stock options, even as many major U.S. banks cut them, and despite its previous awards losing more than $850 million in value since 2008.

Since the height of the credit crisis, U.S. banks have reduced or stopped issuing stock options to employees in favor of so-called restricted stock shares. Like options, the shares cannot be cashed in for several years, but employees can pocket some gains from them even if the stock price falls.

But BNY Mellon is betting options will encourage executives and employees to work hard and be rewarded if its stock price rises.

Still, experts say BNY's contrarian stance could expose the world's largest custody bank to staff departures because executives and rank-and-file employees are more likely to jump ship if the company's stock remains mired at about $22. BNY shares peaked at almost $50 in December 2007.

"This has a very demoralizing effect on employees," said Purdue University professor Ben Dunford, who has studied the impact of underwater stock options on morale.

Competitors that switch to restricted stock could gain an advantage over the bank.

"There's not a lot of appetite for options right now," said Alan Johnson, a top Wall Street pay consultant. "The regulators hate them because they say they encourage excessive risk taking."

BNY employs 48,700 people worldwide and at least two-thirds of their 60.2 million in exercisable stock options were deeply underwater at the end of 2011. About 40 million of the options will expire worthless unless BNY Mellon's share price hits $31, an increase of about 38 percent from the current $22.49.

A group of 10 major U.S. banks and asset managers, including BNY, Goldman Sachs Group Inc (GS.N), JPMorgan Chase & Co Inc (JPM.N) and State Street Corp (STT.N), issued 66 percent fewer options in 2011 than in 2007, according to an analysis of regulatory filings. Employees of the 10 firms have lost nearly $9 billion in paper profits on their options since 2007, according to annual reports.

BNY Mellon was the only company in the group to issue more in 2011 than 2007, granting 8.74 million options compared with 8 million four years earlier. New York-based BNY Mellon declined to comment.

State Street, BNY Mellon's archrival, stopped issuing stock options several years ago and leans heavily on restricted stock in what has become the preferred strategy for many banks.

But BNY's contrarian attitude may yet prove be the right one because it is awarding options when its share price is depressed, Johnson says. Other banks rely too much on restricted stock and should be awarding more options.

"I've been saying that now for two or three years, but on deaf ears," Johnson added.

In its most recent proxy filing discussing executive compensation, BNY Mellon said it reviewed its pay plans to avoid encouraging excessive risk taking. As a result, the bank added some risk-related controls on compensation, such as tying bonuses and restricted stock awards to reaching certain capital levels.

DEMORALIZED EMPLOYEES

Options can produce big gains for employees when a company's stock price rises. They lose all of their value, however, if the stock falls below the price at the time of the award.

Restricted stock continues to grow in popularity at the expense of the "much-maligned stock option," Hofstra University professor Steven Petra and St. John's University professor Nina Dorata wrote last month in the Journal of Accountancy.

Under current accounting rules, restricted stock reduces corporate income less than options. It also is less dilutive to shareholders because they achieve their goal with fewer shares, they said.

BNY Mellon also issues restricted stock, but options remain important. Last month, for example, Chairman and Chief Executive Gerald Hassell received 434,412 options, or 53 percent more than he received in restricted stock, U.S. regulatory filings show.

REPRICING NOT AN OPTION

Even though the Standard & Poor's 500 Index has more than doubled since the stock market's nadir in early March 2009, the financial sector has lagged far behind and most bank-issued options remain underwater. Tens of millions of options have been canceled or forfeited over the past three years as they expired out of the money.

After the dot-com bust, many tech companies repriced their options to keep their talent. But accounting rule changes, such as mandatory expensing along with stricter corporate governance, have made repricing more difficult.

The total intrinsic value of BNY Mellon's outstanding employee stock options, or the paper profits from all in-the-money options, was just $22 million in 2011, down from $875 million in 2007.

Over the past two years, 28.5 million of these employee options have been canceled. That happened largely because BNY Mellon's stock price was below the exercise price when they expired. Options are also canceled if an employee leaves before the vesting date.

(Reporting By Tim McLaughlin; editing by Aaron Pressman, Walden Siew and Andre Grenon)

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McGraw-Hill and CME eye indexes JV: source

McGraw-Hill and CME eye indexes JV: source

Stock Market Predictions

(Global Markets) - McGraw-Hill Companies Inc is in advanced talks to merge its S&P Indices business with CME Group Inc's Dow Jones Indexes, a source familiar with the situation said on Thursday.

A deal would bring together some of the oldest and most widely followed U.S. indexes including the Dow Jones Industrial Average and the S&P 500.

Under the terms of the deal being discussed, McGraw-Hill would own the majority of the joint venture and manage it, while CME would own about 25 percent, the source said.

News Corp's Dow Jones & Co would also own a minor stake, the source said.

The deal has not been finalized and the terms could change, the source said, adding that the talks have been going on for more than a year.

McGraw-Hill and CME declined to comment. News Corp was not immediately available for comment. The story was first reported by the Wall Street Journal.

Standard & Poor's maintains the S&P 500, which was created more than 50 years ago and is one of the most widely followed indexes of large-cap American stocks.

Dow Jones Indexes include the well-known Dow Jones Industrial average of 30 blue chip stocks. The brand was created in 1896 by Charles Dow, a company founder.

Dow and S&P create and license indexes that investors and others use to measure the performance of various markets.

Chicago-based CME Group, the world's largest derivatives exchange operator, offers futures and options contracts based on many indexes and pays fees for licensing rights, where it doesn't already own them. CME bought 90 percent of the Dow Jones' namesake indexes business last year.

Earlier this month McGraw-Hill said it would divide itself into a markets data company that includes its Standard & Poor's ratings businesses and an education company for textbook publishing.

The breakup announcement followed public demands starting in July from the Ontario Teacher's Pension Fund and hedge fund Jana Partners LLC for a broad reorganization.

(Reporting by Paritosh Bansal; editing by Carol Bishopric.)

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