Europe's upcoming corporate earnings season is likely to show whether the renewed optimism about the economy that has buoyed equities in recent weeks is grounded in reality.
The pan-European STOXX index is up 6% since the start of the year, hitting its highest since April after better-than-expected economic data and improved German investor sentiment.
The STOXX 600 index is on course for its best January since 2019.
In a sign analysts were unprepared for such optimism, Citi's economic surprise indicator for the euro zone jumped last week to its highest since July 2021.
In a sign analysts were unprepared for such optimism, Citi's economic surprise indicator for the euro zone .CESIEUR jumped last week to its highest since July 2021.
Recent signs inflation could be softening, improved supply chains, revised global growth forecasts and the sudden easing of three years of COVID-19 restrictions in China have raised hopes the corporate downturn may not be as severe as feared just a few weeks ago.
Falls in gas, oil, and other commodity prices over recent months have also eased some of the pressure on companies' costs.
But Europe Inc isn't out of the woods yet.
"Companies are telling us that it's going to be harder to pass on rising costs to customers in 2023 as economic growth slows," said Nigel Bolton, co-chief investment officer of BlackRock Fundamental Equities.
"We have already seen job cuts and a renewed focus on profitability in the technology sector, and we expect that theme to spread across sectors this year."
On Friday, Ericsson said it would reduce headcount as the Swedish telecom equipment maker aims to slash expenditure.
SLOWEST IN YEARS
Market expectations are already very low. Fourth-quarter earnings for STOXX 600 companies are forecast to have grown by 10.7% year-on-year, the slowest in two years, according to Refinitiv I/B/E/S data.
That's half the level expected just two months ago. Excluding the energy sector, growth would be 4.5%.
Revenue is tipped to rise 4%, the weakest since the first quarter of 2021.
In updates so far, sales from Cartier jeweller Richemont CFR.S and British luxury brand Burberry BRBY.L missed expectations. Europe's largest meals delivery company Just Eat Takeaway.com said orders declined over the quarter.
BofA Global Research said 16 firms had already issued profit warnings for the fourth quarter, with economic weakness limiting consumer spending cited as the most frequent reason.
That's almost half its tally of 35 in the third quarter, which was the highest since the first three months of 2020, at the start of the pandemic.
Refinitiv I/B/E/S data shows Europe Inc falling into recession later in the year too.
Companies are expected to report a decline in earnings for two consecutive quarters: a drop of as much as 6.8% in the second quarter and 8.8% in the third. Earnings are seen bouncing back to growth of 11.4% in the final quarter of the year.
Bernstein Research said its nominal earnings per share growth forecast for Europe for 2023 is at its lowest ever, at 0.6%, while inflation-adjusted earnings are seen falling 5%, reflecting the expectations for a recession in the region.
GLIMMER OF HOPE
Burberry and Richemont provided some optimism, though, noting better sales in China ahead of the Lunar New Year holiday.
For more clues on consumer demand, fashion retailer H&M, Primark's owner Associated British Foods and Europe's largest company by market value, luxury group LVMH , are due to report earnings this week.
Investors will be scouring for comments on China, where surging COVID cases have raised concerns about further disruption after the world's No. 2 economy reopened.
Wages are still a focus as a tight job market and strong growth in salaries add pressure on margins.
"A big question is how the past year's surge in prices will affect wages, potentially delivering a second round of cost rises for companies and creating further price pressures," said Toby Gibb, global head of investment directing at Fidelity International.
With expectations at rock bottom, investors may be prepared to ride out the corporate storm, though.
"If rates volatility subsides, we think equities and cyclicals can cope with a mild profits recession in 2023," said Barclays' head of European equity strategy, Emmanuel Cau.