* 85 percent of S&P500 firms reported met or beat expectations
* Europe poised for most forecast-beating quarter since 2006
By Scott Barber and Dominic Lau
LONDON, Oct 28 (Reuters) - European companies are matching and beating profit expectations at a rate unseen since 2006 and the U.S. trend is also above average, a signal that investor pessimism may be overdone, analysts say.
With around half of the companies in the S&P 500 having reported third-quarter 2010 earnings so far, 85 percent have matched or beaten estimates, compared with 79 percent in the average quarter over the last five years, according to Thomson Reuters data.
Early signs in Europe point to an even stronger quarter in terms of forecasts, with 73 percent in line with or above expectations compared with 60 percent on average, the highest upside surprise rate since 2006.
The European earnings season is at an earlier stage, but strategists are encouraged by the data.
"The clients that we speak to are very sceptical about the 2011 numbers," said Robert Parkes, equity strategist at HSBC. "We actually think they will be delivered. We are more optimistic on the earnings story. The scepticism from the market is reflected in current valuations, which are at an attractive level in our view."
CASH GENERATION
Another signal the results are sending is that companies are finding themselves with surplus cash.
"Companies are doing very well but instead of investing their profits and creating economic growth they are hoarding money," said Mark Bon, a fund manager at Canada Life.
"Like investors, they are behaving very cautiously ... Corporates are doing very well but are reluctant to invest in growth."
Some believe a bonanza of share buybacks and a further pickup in M&A activity could be destination for this cash.
"What we have seen at the moment is that companies are generating very strong cash flows," said HSBC's Parkes.
"Up to that point, they have not deployed that money. It's been sitting on balance sheets. The next stage is companies will deploy that money. They can return to shareholders or they can invest it ... We actually believe both areas will pick up at the same time."
Results strength has been broad-based across defensive and cyclical stocks, with the industrials and technology sectors seeing some of the biggest percentage surprises in aggregate.
Analysts now expect earnings for the MSCI World Index to grow 37 percent for 2010, but that number has risen from 28 percent at the start of the year as firms have surprised with their ability to grow earnings.
Further out, while a more moderate 15 percent growth rate is expected for 2011 there is still the potential for disappointment if global growth does turn down.
Forecasts for sales growth are more conservative, with 7.6 percent for 2010 and 5.7 for 2011 suggesting analysts think companies will continue to need to look for cost cutting and margin improvements to drive earnings.
Global equities have responded to stronger earnings and hopes of further monetary easing with the MSCI World Index rising 11.4 percent over the last two months.
Despite this strong performance, equity valuations have yet to rise above their long-term averages -- the S&P 500 12-month forward price earnings ratio stands at 12.7, compared to its 25-year average of 15.3. Valuations versus government bonds look more favourable with an earnings yield of 7.9 percent, compared to a yield of 2.6 percent on 10-year U.S. government bonds. (Writing by Andrew Callus; Editing by Jon Loades-Carter)