We are on the cusp of yet another season of earnings decline for the broad market. If earnings do fall year-over-year as expected it will be the 5th quarter of declines. Growth is expected to return later this year, starting with the July quarter, but the way estimates have been falling over the past few months there is no guarantee it will happen. If you add in the tepid state of economic growth, the Brexit vote and a resurgence of dollar strength the outlook for earnings growth only gets gloomier. In this run-down I will be looking at the broad market and the ten sectors that comprise it from an earnings and earnings growth standpoint. I will be using the weekly charts.

S&P 500 - SPX/SPY

Over the course of the past three months the broad market has extended its bounce from the January/February bottom and met resistance just below the current all-time highs. What should be noted is that while the index was moving higher, earnings expectations for the 2nd quarter, 3rd quarter, 4th quarter and full year were all in decline and have yet to bottom. Q2 projections, which had been positive as recently as late January, fell deeper into negative territory. Q3 projections have fallen to just 1.2% and are at risk of turning negative, Q4 projections remain strong at 7.5% but far from the +14.4% predicted in January.


Over the past few weeks price action has been dominated by the Brexit, the surprising result of the vote and the sell-off/rebound that occurred in its wake. Underlying that however, is anticipation for the upcoming earnings season. For perspective, since the end of the last quarter 9 sectors have been revised lower for Q2, 6 have been revised lower for full year 2016 and 6 have been revised lower for 2017.

On a technical basis the market has nearly recovered 100% from the Brexit sell-off but that is not saying much. The SPX is still below long-term resistance with indicators consistent with potential reversal. Should the market correct on earnings support along the long term up trend line is possible and a target for bullish entries.


It is possible that earnings for the 2nd quarter will be better than expected, the average amount of change between the pre-season expectation and the final tally is about 4% so there is a chance we'll see growth decline only about -1%. This may be enough to get the market moving higher but I think it will come down to forward outlook and 3rd quarter/full year projections than anything else. Looking to the full year 2016 projections have fallen from about 10% to only 0.7% over the past 6 months and are in danger of turning negative.


The Energy Sector - XLE

Once again the energy sector is expected to post the largest decline in year-over-year earnings. Despite the rise in oil prices projections for the quarter and the full year have been falling. At the beginning of the 1st quarter the sector was expected to post a full year decline of -54.8%. This fell to -62.9% at the beginning of the 2nd quarter and stands at -67.1% now. Projections for the current season have also been in decline, if only marginally. 2nd quarter projections were -76.2% at the start of the quarter and have fallen to -77% as of last report. The good news is that sector is also expected to see robust growth in 2017 and those estimates have been on the rise. At the start of the 1st quarter 2017 estimate was +147%, it was revised upward to +187% at the start of the 2nd quarter and have recently risen to a high of +217%.

The XLE Energy Sector SPDR has been in recovery since hitting bottom earlier this year and set a new 2016 closing high just this past week. There is upside potential in the sector, the past week saw it move up from the 150 day moving average, with a target near $72.60 if resistance at the $70 level can be broken. The caveat is that this move will be dependent on oil prices which appear to be stalling out around $50. While the long term outlook for growth is positive there are warnings signs in the charts that the rally in energy stocks may stall in the near to short term. Momentum is to the upside but is diverging from prices while stochastic has fallen below the upper signal line and forming a potentially strong bearish crossover.


Materials - XLB

The materials sector is expected to post the 2nd largest decline in earnings this quarter. Since the end of the last quarter earnings projections have been revised lower the current quarter while the full year has been revised higher. Q2 projections have fallen to -11.3% from -10.9%, full year 2016 projections have improved to -1.3% from -3.7%. Looking out to next year estimates have fallen by more than 2% to 15.7%. Like the energy sector, the dog of 2016 is expected to be a leading sector next year.

Over the past quarter the materials sector extended its bounce to the $48 resistance level and has since corrected. In recent weeks the sector has tested support at the 150 day moving average, confirmed by candles, and may do so again. Resistance is at $47-$48 but there is little indication of upward movement at this time. The indicators are both showing some weakness that could lead to further downside should support levels near $45 be broken. Weakness is shown by the bearish crossover in stochastic and an impending confirmation in the MACD. Should a correction continue to fall below the $45 level first target for support is near $44 with additional targets near $42 and $44. Looking forward, with 2017 expectations so strong, weakness in near to short term prices will likely be opportune times for longer term entries.


Information Technology - XLK

The Information Technology sector is expected to post the 3rd largest decline in earnings for the 2nd quarter. It has also seen the 2nd largest downward revision in expectations since the start of the quarter, -7%. 2nd quarter projection now stands at -7.2%, down from -0.2%. Full year estimates have also fallen but not quite so sharply, down to 2.3% from 4.0%. Next year is expected to be much better, growth is expected in the range of 11.3%, but has fallen by a half percent since the end of March.

This sector has been range bound for the last year. Since the start of the 2nd quarter the sector has fallen from resistance made a lower high and a lower low and all confirmed by bearish indicators. In the past week the sector has seen a bounce that could take it to the top of the range although the move does not look strong. Stochastic has made two bearish crossovers below the upper signal line since the end of March, the most recent confirmed by a bearish crossover in the MACD, indicating underlying weakness in the sector. Current resistance is near $44, just above current price levels, and could be a good entry for bearish positions with own side targets near $42, near the middle of the range, and $40, near the bottom of the range. Longer term outlook, should earnings projections remain stable, is good so near to short term weakness is a likely starting point for a longer term rally.


The Financial Sector - XLF

The financial sector is projected to post the 4th largest decline in earnings this season. Current estimates call for a –3.2% decline, down from -0.4% at the beginning of the quarter. Full year 2016 projections have also fallen, down nearly 50% to 2.6% from 5.8% at the start of the quarter and down from nearly 8% at the start of the year. Next year is much brighter however, estimates have been on the rise recently and now stand at 12.6%, up from 10.7%. Positive factors supporting the sector, especially in the longer term, are positive trends in labor and strengthening in the consumer.

Despite positive outlook for full year and 2017 earnings growth this chart is one of the weakest looking of the group. The sector was able to extend its bounce from the January low and Dimon Bottom but uncertainty over the FOMC rate hike and global economy have sent it into correction over the past few weeks. It has been able to recover some of the losses since the Brexit driven sell-off but has yet to regain the upper side of the 150 day moving average, now resistance, and the indicators are not promising, both MACD and stochastic are forming strong bearish crossovers. Resistance is just above the current levels, near $23 and the 150 day moving average, with support targets near $21 and $20.


Consumer Staples - XLP

The consumer staples sector is expecting to see a decline of Q2 earnings of -2.9%, down from -1.9% at the beginning of the quarter. Full year estimates have seen some fluctuation over the past 3 months, falling a bit to a low of 2.5% but rebounding in recent weeks to 3.5% and just below estimates from earlier in the year. Next year is about the same, fully year 2017 estimates have seen some fluctuations but have rebounded in recent weeks to match levels estimated in early January near 9.5%. Of all the sectors this one is the best positioned, based on labor and consumer trends, to beat projections in the current quarter, full year and next year. Recent consumer spending numbers were better than expected and have led the Atlanta Federal Reserve to up its full year spending forecast.

The XLP Consumer Staples SPDR has been moving higher over the past quarter, driven by rising full year earnings outlook and strength in the consumer. The XLP reached a new all-time high this week, after a small dip on-post Brexit fears, and appears set to move higher. The moving averages show a clear up-trend but the indicators are weakening so a little caution is due here. Divergences are present in both indicators but they are also both rolling into new buy signals that could carry it higher, especially if earnings are better than expected.


Industrials - XLI

The industrials have seen a mixed bag of earnings revisions. Estimates for the 2nd quarter have improved over the past 3 months, rising to -1.9% from -4.2%, while full year projections have fallen to -0.7% from -0.1% at the beginning of the quarter and from +3% at the beginning of the year. Looking out to next year 2017 full year projections have remained fairly steady around 9.5% but have fallen slightly to 9.3% in recent weeks. Risks for this sector abound including slowing China, political upheaval in South America and Brexit fallout so I would not be surprised to see outlook fall in the coming weeks.

The XLI Industrial Sector SPDR did not do much over the past 3 months except form a congestion band beneath resistance. The fact that it has been able to hold steady at/near current levels is promising but the indicators are consistent with resistance and possible correction so a pull back to test support is possible. Resistance is just above current levels, near $57. First target for support is near $54.50 and the 150 day moving average, a break below this level could take the sector down to $52 or lower, depending on how earnings and outlook are reported.


HealthCare - XLV

Expectations for the healthcare sector are positive this quarter but a bit mixed as well. For the 2nd quarter, projections have fallen from 2.8% to 2.1% while full year estimates have risen to 7.3% from 6.5% at the beginning of the quarter. Next year is still expected to see positive growth, about 10.5%, but that growth has been revised lower since the start of the quarter. In terms of outlook this sector, in my opinion, has the most risk since it is linked closely to Obamacare and the upcoming election. Obamacare is without doubt driving a lot of the earnings for the sector, if it implodes or is repealed those earnings will vanish. At the very least there is potential for a lot of volatility as insurers and providers report results and guidance. I've been staying away from the sector because of this risk and I will continue to do so into the future. This does not mean there are no opportunities here, I just choose to avoid them in favor of other less questionable options.

The XLV HealthCare SPDR tread water over the last quarter, similar to earnings outlook, and has formed a small congestion band around the $70 level. The band is near the mid-point of a near 2 year trading range between $63 and $77 with indicators consistent with that range. Over the course of the past 18 months MACD has been very weak and without clear indication of direction while stochastic has been trending between the upper and lower signal lines, also without clear indication of direction. In order to move higher the ETF will need to break through short term resistance at the $73 level. This level has provided resistance numerous times over the past 12 months and looks like it could do so again. At present the indications are mixed, momentum is to the upside but stochastic is moving lower and neither giving much indication of where the ETF is headed in the near term.


Utilities - XLU

The utilities are expected to post the third largest earnings increase this season although estimates have fallen in recent weeks. 2nd quarter earnings growth is expected to be 3.8%, down from 4.7% at the end of March and about 7% at the end of December. Full year expectations are also falling, down more than 10% to 4.4% over the past 3 months. Next year's earnings estimates have been holding steady at 3.7% since the beginning of the year.

This chart is the best looking one of them all and that is likely due to the dividends. The utilities have long been known as a great payer of yield and in the current slow to no growth environment are attractive to say the least. Current yield on the XLU is about 3.1%. When compared to the SPY's 2.6% is not so great but when you drill down to individual stocks you can find yields in excess of 4% with positive coverage and opportunity for dividend increases. Duke Energy for example is yielding about 3.85% at today's prices, Southern Company about 4.15%.

Since the end of the last quarter the XLU has shot up to set multiple new all time highs and is the only sector to not sell-off in the wake of the Brexit vote. The indicators are bullish and on the rise, stochastic is making a bullish crossover of the upper signals line, so it looks as if this run has some room to move higher. There may be some consolidation at the current level, near $52.50, or even a pull back, but any weakness here is likely an buying opportunity for near to short term positions. Upside target is $55.


Consumer Discretionary - XLY

In terms of earnings outlook the consumer discretionary sector is among the best looking of all the sectors although 2nd quarter estimates have been falling. Q2 projections now stand at 6.4%, down from 9.6% at the start of the quarter. For the full year, estimates for 2016 have been on the rise in recent weeks, up nearly a full percent to 11.1%. Full year 2017 estimates have fallen as well but remain strong near 12.5%.

The XLY Consumer Staples SPDR is caught within a range despite rising full year expectations and expected strength next year. Since the start of the 2nd quarter it has brushed up against the upper range boundary several times and in the wake of the Brexit hit a four month low. Most recently it has made a bit of a rebound off the Brexit Bottom but indications remain weak. Both indicators are mixed but show signs of support that when paired with price action give the impression it could test resistance near $80 again. A break above this level would be bullish with upside target near $82.50 in the short term. Longer term I like this one, if there is any weakness over the next month or two it will be a likely buying opportunity.


Telecom - XTL

The telecoms are the expected to be the strongest sector this quarter. However, they are also expected to be the worst sector next year after the utilities with full year 2017 growth of only 4.2%. This season they are expected to post earnings of 7.8%, down from 11.4% at the end of March, with negative growth for the full year 2016. Full year 2016 expectations have also been falling, down to -6.5% from -6.2% in March. Based on the fact that the first quarter saw growth of 16.6% and the full year is projected to see negative growth I expect to see Q3 and Q4 earnings growth deeply negative.

Declining earnings growth is a major problem for this sector and you can see it in the charts. Price action has been extremely choppy over the past 12 to 18 months and range bound. Resistant is just above the current level, near $58, and looks like it is strong. The indicators are both showing divergences, stochastic a bearish crossover, so a retreat to support is looking more than likely. First target for support is near $55.


Conclusions

On a sector by sector basis I am bullish on two sectors; consumer staples and the utilities. Energy and consumer discretionary are a possibility. I am neutral to bullish on energy dependent on where oil prices go, mildly bullish on discretionary depending on earnings and outlook. Other than that the remaining 6 sectors are not looking to good for near to short term prospects.

Speaking of the energy sector, with earnings growth outlook so strong I can't help but think it will rally the strongest when the bull market resumes but maybe not until much later in the year or next year. Consumer discretionary is another where I lean toward neutrality. The sector is range bound and needs to break resistance in the near to short term. Ongoing recovery in labor, earnings and spending lead me to believe earnings could be better than expected. If so a move to the upper end of the range and break-out is very possible.

The two sectors I am really bullish on right now are the Utilities and Consumer Staples. The utilities are seeing big gains on earnings, but also on dividends and safe haven plays so the march to new highs could very easily continue. The consumer staples is my top choice for near and long term plays. It is pushing new all-time highs led by the same labor trends and improvement in consumer spending that is aiding the discretionary sector without the risk associated with discretionary spending.

While I remain bullish for the 2nd half of the year and through 2017 the nearer term is looking increasingly weak. I've been anticipating a correction for some time now and nothing in this run-down has changed that. Except for the consumer discretionary and utilities sectors every major sector is trading beneath resistance with bearish indicators and weak or negative earnings expected, a set up for potential reversals.

The thing to do now is to wait for earnings to begin rolling out. We've just a week to go before Alcoa and the big banks begin to report, when they do we'll get a good idea on what to expect the rest of the season. I suspect we'll get a correction, more of a sector rotation, but I think it will lead to a bull market that could last until the end of 2017.

Until then, remember the trend!

Thomas Hughes