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Citi

Looking Beyond 4Q 2020 Earnings

Firms globally are expected to close out their books for 2020 in coming weeks. As the spike in new COVID-19 cases late in 2020 led to a ramp-up in restrictions across the US and Europe, 4Q 2020 could be another negative quarter for US and global earnings per share (EPS) growth. However, focus is likely to be on a strong year of earnings growth ahead. The speed and magnitude of the recovery could dictate the path for equity markets this year. Much could depend on how long it takes to inoculate the global population, though further stimulus in the US and elsewhere could provide a boost to demand in the interim.

 

At a regional level, Europe and Emerging Markets outside North Asia could see the strongest earnings recovery this year. While Europe was hit hard by the COVID-19 crisis given the significance of tourism and manufacturing as a share of the regional economy, a swifter bounce-back is expected with political issues like Brexit in the rearview and EU-wide stimulus on the way. Emerging economies tied to global supply chains, such as Latin America and Southeast Asia, could also stand to benefit from supply chain diversification post COVID-19, as US and Chinese multinationals seek to become less co-dependent.

 

Inflation and taxes are potential risks to watch but may not threaten profitability in the near term

The Federal Reserve is unlikely to prematurely tighten monetary policy until unemployment meaningfully improves, even if this means tolerating inflation above the 2% target for a year or more. However, Citi analysts think that reflation is unlikely to mean runaway inflation.

 

With the Democrats in control of the White House and Congress, a large spending package paired with marginal tax hikes has grown more likely in the US. However, it is premature to say which sectors could be impacted, or when any tax hikes could ultimately take effect.

 

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Emergence from COVID-19 could benefit certain sectors more than others

  • Information Technology – Some reduction in personal office investment could be expected, perhaps to the benefit of IT firms focused on corporate office technology.
  • Banks – Banks may face less regulatory scrutiny and improving loan loss reserves. Rising interest rates and a steepening US yield curve are also supportive for net interest margins.
  • Industrials – There may be potential opportunity for further recovery, given the backlog in manufacturing orders and likely recovery ahead in aerospace as flight demand resumes.
  • Energy & Materials – Sectors linked to cyclical commodities tend perform well early in an economic cycle. But the earnings recovery may be temporary, particularly among traditional energy companies as demand for “clean” energy is likely to grow in coming decades.
  • Health Care – A strong earnings recovery is expected in the year ahead, as a resumption of “normal” care could improve provider margins and drive further demand for medical equipment. Sector valuations are also historically cheap relative to the broader market.

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