Article02 Sep 2022

European Equity Strategy: EPS Recession

Citi Research’s European equity-strategy team has published a report lowering its top-down EPS expectations based on the increasing likelihood of a recession and cutting its 2023 real GDP forecasts. Citi economists now expect a decline of 1% for the euro area and 2% for Germany.
The chief culprit? Rising prices for gas and electricity. At current prices, Germany’s 2021 gas consumption would cost close to 6% of its GDP, compared with just 0.3% in 2019. For the EU as a whole, the cost of gas would eat up nearly 7% of GDP, up dramatically from 0.4 % in 2019. 

These high prices have damaged household and business confidence. They’ve also created headwinds for industrial production. Manufacturing uses nearly 30% of Germany’s gas, with industries most at risk of impact from rising prices including chemicals, paper, cement/ceramics, and basic metals. Given ongoing supply constraints, these industries would need to halve their usage of gas to ensure sufficient levels going forward. Citi Research economists estimate that cutting these industries’ output in half would contribute to a 1.5% fall in GDP. That raises the prospect that fiscal intervention will be needed. That assistance could come via targeted support for businesses through cheap, government-guaranteed loans to preserve liquidity, or furlough programs to prevent job cuts. 

In the short term, the European Central Bank may well proceed with its rate hikes and perhaps accelerate their pace, the authors note. But when recession proper sets in and governments have to support the economy, coordination between monetary and fiscal policies may return. That means rates could peak by the end of the year. 

A Forecast That Bucks the Consensus

With a deeper euro-area recession now forecast, Citi Research’s European equity strategy team is updating its top-down earnings-per-share (EPS) forecasts for European equities excluding the United Kingdom. It now expects a 10% EPS contraction over the next year, in line with prior risk scenarios, with EPS contracting 2% this year as macro headwinds intensify in the second half.

Europe ex UK TOP-Down vs Bottom Up EPS Growth Forecasts


Citi’s top-down forecasts are much more bearish than the current bottom-up consensus—collectively, analysts now expect 9% EPS growth this year and 6% growth in 2023. Excluding the commodities sectors—energy and materials—those EPS growth expectations look more reasonable at just 1% for 2022. But with Citi’s commodities strategists expecting meaningfully lower oil prices, energy-sector earnings could also be at risk. 

How would the 10% EPS contraction that Citi Research expects impact various European sectors? The strategists examined that question using a regression framework drawing on the last 13 years of historical data and concluded that materials, financials and consumer discretionary sectors might see earnings contractions of between 14 and 16%, with health care and consumer staples sectors likely holding up better. 


10% EPS Contraction Potential Impact on Sector EPS


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