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Q3 earnings will 'surprise on the upside' due to underlying economic strength: Deutsche Bank Managing Director

Stocks are rising ahead of big bank earnings. Deutsche Bank Managing Director and Global Head of the Fundamental Credit Strategy Group Jim Reid joins the On the Move panel to discuss.

Video Transcript

ADAM SHAPIRO: It is earnings that we're going to be focused on for the next couple of weeks, and we kick off big bank earnings tomorrow. We've got BlackRock, JPM, Citi. They're among those who will be reporting. And we invite into the stream Jim Reid, Deutsche Bank's Managing Director and Global Head of the Fundamental Credit Strategy Group to help us preview what to expect this earnings season.

Before we jump into the big financials, Jim, it's good to have you here, but I am curious. You do expect the quarter to overall remain negative as far as earnings growth, but then 2021, you're quite optimistic. Why is that?

JIM REID: Well, actually I think this quarter coming up will be very interesting because the market expects gains to be there, but a lot of those gains will actually-- that the market is expecting will be in loan loss provisions reducing and also at the energy sector. Actually, underneath the surface we don't think the market is actually pricing in a big enough rebound in earnings. So they're artificially going to look good because of loan loss provisions and energy, but actually underlying because of the economic strength being bigger than analysts expect, we actually think Q3 is actually going to surprise on the upside.

JULIE HYMAN: Hi, Jim. It's Julie here. Thanks for being with us. So does that apply just to banks, or would you say that that is broadly true for this reporting season coming up? And if it is broadly true, where do you think we'll see areas of particular strength? And do you think that companies will then be rewarded for upside surprises, especially given the run that we've already seen?

JIM REID: Yeah, I'd say it's probably outside of the banks, really, because most of the improvements that analysts expect are in banks and energy. We don't think enough credit has been given for the other sectors because when we regress it against how much GDP has beaten what analysts were expecting GDP to be in the third quarter, we don't think earnings are high enough yet for the other sectors relative to expectations.

However, you raised a very good point on the second point. Will markets reward companies for that? And that's more difficult because positioning now in equity markets in the US is much more neutral than it was before the Q2 earnings. It's a similar story to Q2 earnings. Analysts weren't expecting enough in terms of analyst-- sorry, in terms of market beats. But this time, markets go into this season a bit more neutral, and obviously markets have already rallied on a Biden blue wave in the election. So I don't think there's as much upside in equities, but I think there's more upside in earnings than people think.

BRIAN CHEUNG: Hey, Jim. Brian Cheung here. So on that basis, does that mean that any sort of asset reallocation should be within equities and moving from one sector to another? Because as we know, even though the rally-- there has been a rally in the equities market, there's been varying degrees of who's loved and who's unloved in this market right now-- financials being largely unloved, tech stocks being loved. So where do you reallocate, if that is the case if you're trying to move from those kind of, I guess, not so good-looking companies to the better-looking ones?

JIM REID: I think there's probably scope for the value stocks to have more of a chance of a rally than the growth stocks at this stage. That's certainly where, if we're right in what we said, that's where there would be rotation, yeah.

JULIA LA ROCHE: Hey, Jim, Julia La Roche here. I was hoping we could broaden it out a bit because I know you as someone who focuses a lot on macro, and here we've been talking a lot about what's going on with US equity. Of course, the stimulus was kind of the big story of last week. What are some of the things that are on your radar these days that our viewers would be interested in?

JIM REID: Well, I think the stimulus debate is an interesting micro, day-to-day debate on will they, won't they get something done before the election? But I think markets have already moved on to pricing in a kind of blue wave in the election and therefore big stimulus in Q1. So I suppose the risk the market has is that you get some kind of divided government.

I don't think the market really cares too much whether Trump or Biden wins, but I think the market wants a decisive, you know, political system at the end of November the 3rd that can get stimulus through. And at the moment with the probabilities as they are, they see that as being most likely if there's a blue wave. So Democrats also get the Senate. So that's what markets are really focusing on.

I mean, with COVID-19, markets seemed to be pricing in a vaccine coming through at some point in the next six to nine months. So they're prepared to kind of look through the restrictions in the short term because they're pricing in more of a vaccine. So if you've got bad news on a vaccine, that would be a very bad moment for markets.

ADAM SHAPIRO: But which banks-- I want to specifically go back to the financials-- do you think investors are going to be most focused? Is it going to be Jane Fraser perhaps coming earlier at Citi? Is it going to be Bank of America? They were indicating they could have a much better revenue picture when they start reporting. Or is it going to be, you know, the asset cap at Wells Fargo? What do investors key in on, which banks specifically do you think?

JIM REID: Well, I think-- look, as a macro guy, I'm not really the one to talk about micro individual banks, but I would say the big concern in Q2 earnings was loan loss provisions. So I think markets will be very, very attentive to loan loss provisions because the actual volatile nature of markets means that the actual numbers from banks will be-- well, should be reasonably good. Investment banking is having a good time with volatility but the sting in the tail is how much loan loss provisions there are.

So I think that's the thing that most analysts will be looking at, you know, what loan loss provisions are going to be. And they're going to be lower in Q3, but any guidance or any justification for that will be really picked upon.

ADAM SHAPIRO: Jim Reed is Deutsche Bank's managing director and global head of the Fundamental Credit Strategy Group. We appreciate your insight here "On the Move."