It seems that the earnings season in Europe is showing us its kind face after more than six years of disappointments and constant downward revisions (read). The earnings recession has been evident in domestic turnover, tax bases and the ability to repay debt, which did not improve in Europe despite the low interest rates – because cash generation was deteriorating more quickly.

According to Morgan Stanley, out of the 75 companies that have reported – although it is only a small part, 15% of the market capitalization – 43% have beaten estimates by 5% or more, while only 29% have disappointed. The rest were”in line” with expectations. So far, these have been the best results of the past 6 years.

Faith in earnings recovery is centered on four pillars:

. Better commodity prices – which helps oil companies and electricity generators -,

. improvement in the performance of banks with more inflation and less provisions,

. upward revisions of global growth

. …and widespread margin improvement.

There are still many results to analyze, but it is worth noting that this recent improvement is promising, albeit not without risks.

– It is true that a little inflation would help the financial sector to get their head above water and breathe a little. Banks are trying their own medicine. They spent years demanding monetary expansion and now they suffer the collapse of margins due to negative real interests. But the European banks’ writedown trend is far from over, and the burden of NPLs (non-performing loans), which exceeds €200 billion, still require a large number of capital increases. The recent results by Deutsche Bank show that the pain is far from over.

– The recent increase in commodities has not generated the positive results that consensus expected in energy. The results of the large European conglomerates are, so far, quite poor, with only one exception, Total, that has been doing its homework for many years.

– We have to pay attention to the negative surprise in the earnings of Consumer Staples, a 7% negative surprise and 5% overall decline, as European growth expectations come mainly from the hope of higher consumption.

Of course, analysts and investment banks are encouraged by the increase in inflation. However, we have to pay more attention to core inflation, since we may encounter a stagflation problem if prices rise due to food and energy while the economy remains anemic.

In any case, we must highlight the good news. If the positive surprise in earnings is maintained until the end of the results season and extended to 2017 guidance, we could be facing the end of the earnings recession, which is an essential factor to believe in a true recovery.

If this profits recession is not reversed in 2017, we could face a much greater problem. Why?

If profits do not start to grow in Europe in 2017, the “tailwind” effect of low interest rates and cheap commodities will dissipate before companies have improved their ability to reduce debt.

European companies can be the positive surprise of 2017 despite the political turmoil and the likely ECB tapering.

Many investors tell me all this does not matter, because European stocks are cheaper than the US market. Let me give a warning. It’s almost always the same. Apart from the fact that the composition of the indices is very different -technology and high added value in the US compared to low-growth banks and conglomerates in Europe-, investors must remember that when US companies have excess cash and liquidity, they buy back shares and increase dividends. European companies, the vast majority, don’t.

We have to follow the earnings trend. It’s tedious and less sexy than talking about political conspiracies, but without an obvious and unquestionable improvement in corporate profits, the European rebound will be nothing but a mirage… again.

Daniel Lacalle. PhD in Economics and author of “Life In The Financial Markets”, “The Energy World Is Flat” (Wiley) and forthcoming “Escape from the Central Bank Trap”.

Graph courtesy Morgan Stanley