Introduction

Second quarter earnings didn't slow as much as feared, expect more of the same in the third. Why, because of chronically declining earnings estimates. This trend has been going on for years, outlook for forward quarters begins robust but slowly deteriorates as analysts second guess themselves, lowering their own targets until there is no question but that they will be beat. This is true of the current quarter, outlook has fallen nearly 6% from a high near 8.2% to the current rate of 2.8% and the first reports have easily beaten their targets.

On average, the final rate of growth for each quarter over the past 4 years has come in about 4% higher than it was at the beginning of the cycle which means we may see this quarters growth come in near 7% by the end of the cycle.


The good news is that forward outlook, although still suffering chronic decline, remains positive and robust. Growth is expected to expand to 11.1% in the 4th quarter and then hold steady in the range of 10.5% for the 1st and 2nd quarter of 2018. Based on full year 2018 outlook, +11.4%, I expect to see earnings growth expand above 12% in the 2nd half of the year.


So, of the 11 S&P sectors 9 have been revised lower since the start of the 3rd quarter, led by the energy sector. Because of this we are only expecting to see 7 sectors show growth, once again led by the energy sector. Overall, and on a long term basis, the energy sector has has the most effect on forward earnings growth outlook over the past 2 years. Now that oil prices have risen from their lows there is a chance forward outlook for the sector and the S&P 500 as a whole could begin to rise. At the very least, which oil prices semi-stable in the $45-$50 range, we may begin to see less volatility in the numbers. If, and this is a big if, forward earnings outlook begins to rise it will mean 3 of 3 earnings factors I consider to be important have been met; positive earnings, expanding forward outlook and increasing estimates.


The most recent decline in full years estimates are however due to the insurance group. The recent round of devastating storms has set them up to miss quarterly and full year estimates, and possibly even next year. In the last week estimates have fallen in the hundreds of basis points; Everest Re -618%, XL Group -322% and Chubb 1110%.

The S&P 500 Since The Last Earnings Cycle

Looking at the weekly chart of the S&P 500 we can see that the index has gained about 100 points or 4.1% since the last earnings season began. Coincidentally the index had completed a similar move at the last earnings season check-up, about 100 points or 4.4%. The index has extended the Trump induced rally to new all time highs and has met or exceeded targets set previously. The index is currently in the midst of short term rally and indicated higher by both stochastic and MAC. Both indicators are firing longer term bullish crossover and entry signals with target in the range of 2580 to 2560.


The daily charts is a bit mixed but generally bullish. The index is in rally mode going into earnings season but may have entered a consolidation period. Both indicators are generally bullish but both are also consistent with a peak within an uptrend. This does not mean impending correction but it does leave that possibility on the table. If this turns into more than a quick dip to support the move could go as low the short term moving average near 2,500. That would be a correction of near 2% from current all time highs and if so would become a likely entry for new bullish positions.


Second Quarter Earnings; Sector By Sector

The Energy Sector (XLE)

The biggest story in earnings over the past 2 years has been the energy sector and it still is. It was the leading cause of the earnings recession and is expected to be the leading driver of growth now that earnings are on the rebound. Earnings growth expectations for the sector were astronomically high in previous quarters but fallen to a more reasonable 110% for this quarter and 90% for next. Full year 2017 estimates are still quite strong at 243% but moderate to only 35.5% next year. These estimates have been volatile due to wild swings in oil prices over the past two years. With oil prices trading at the high end of the range forward outlook could begin to rise and help lift the sector.

At last look the energy sector was beginning to show signs of support and that support held, more or less. The XLE Energy Sector SPDR moved down to set a new low below my initial support target but managed to regroup and bounce higher. The ETF is now in full reversal and setting up for looks like another leg higher for the near term. It is trading above the $68 resistance target set at the start of last earnings cycle and looks like it will continue moving higher. The indicators are showing bearish crossovers at this time but with the ETF trading sideways as it this is more of an entry signal than not. A break above near term resistance at $69 will be bullish with upside target near $74. I am cautiously bullish on this sector.


The Industrial Sector (XLI)

The Industrial sector is expected to show earnings growth for the 2nd quarter in a row. The sector is expected to post growth of 2.2%, roughly in line with the last quarter, with that growth expanding into next quarter and next year. Fourth quarter 2017 is projected at 10.2%, down a bit over the past month, with full year 2017 at 5.1% and full year 2018 at 10.1%. Strengthening domestic and international growth along with favorable conversion rates should add additional tailwind to earnings moving forward.

I was bullish on this sector last quarter and I am bullish on it now, although a bit cautious for the near term. At last look it was up roughly 6% on the quarter and has performed similarly in the time since. The ETF is now trading at new all time highs and likely to set additional new all time highs in the short to long term. The near term outlook is a little cloudy as the indicators are diverging from the latest high and rolling over into bearish crossovers. This does not mean it will fall, just that there is some weakness present. Thinking positively, that weakness could easily pass with strong reports from big name companies. A fall from this level would not negate the up trend, a decline of roughly 5% would put it at the short term moving average and a possibly entry for new bullish positions. A move up from here would confirm continuation of the trend with upside target near $76. I am cautiously bullish.


The Telecom Sector (XTL)

The Telecom sector is not expected to produce growth this quarter or for the year, and outlook for both this year and next year are down. The sector is now expecting to see a decline of -1.4% this quarter, down from positive expectations earlier this year, with full year 2017 coming in at -0.7%, also down from earlier in the year. Forward outlook is at least possible but it is dismal compared to other sectors in the index. Fourth quarter 2017 is expected to return to growth, 0.6%, and expand into 2018, 2.0%.

I was neutral to bearish on this sector last quarter and that turned out to be right. The sector performed dismally at earnings, lowered forward guidance and fell through my support targets at $70 to test next targets at $69. The sector remains range bound with little hope of moving out of it short of some miracle in the revenue, margins and/or earnings departments. I am neutral, not bearish, this time around simply because there is growth in the forecast but I am not overly optimistic.


Consumer Discretionary (XLY)

The Consumer Discretionary sector posted one of the largest earnings declines last season and was expected to return to growth this season but estimates have fallen and now it is expected to post another decline, -2.8%. The good news is that this should be the last quarter of declines for this sector. Looking forward 4th quarter growth is expected in the range of 7.1%, 3.5% for the fully ear 2018, with that expanding into 2018. 2018 should see growth expand to robust levels, above 10%, and with the tailwind of ongoing improvements in labor and wages may actually happen.

At last look I was cautiously bullish and the cautious part was right. The ETF moved higher within a range but gains were capped at long term resistance and later erased as forward earnings outlook deteriorated. Looking forward, assuming growth does indeed return, the ETF is set up for gains. It has recently completed a bounce form long term support at the 150 day moving average, consolidated above the short term moving average and rallied higher. It is now in consolidation just below all time highs with bullish indicators and positive forward outlook. A break to new highs would be bullish and could take it up to $96 in the near to short term. Cautiously bullish.


The Healthcare Sector (XLV)

The Healthcare Sector has not been my favorite for some time and that really hasn't changed. Political risk is still abundant but one thing remains clear, the industry makes a lot of money and it is getting bigger every day. Current outlook is fairly weak but positive, 2.5% for the 3rd quarter, with that expanding to more acceptable levels by the end of the year and into next year. That being said full year growth of 5.4% in 2017 and 8.5% in 2018 is only middling compared to the pack.

Last quarter the Healthcare SPDR XLV was moving higher with the expectation of testing resistance. The ETF did indeed test resistance and after a brief pull back to strong support it broke through. It is currently trading just shy of the new all time highs and in what looks like a short term consolidation pattern. Price action is forming a possible triangle pattern with bullish outlook. The caveat is the indicators, they are both bullish but showing signs of range bound trading and not indicative of strength or direction. Support is near $81 and the short term moving average, resistance near $83.50 and the all time high. The next move will come down to earnings and outlook. If the sector meets or exceeds, particular with forward outlook, a break to new highs is likely. I am cautiously bullish with an eye on possible entry at the short term moving average. Upside target near $86 for the near to short term.


Consumer Staples

The Consumer Staples sector is expected to post growth for the quarter, the year and next year although those estimates are tame compared to the market leaders. This quarter should come in around 1.6% with that expanding to 5.0% next quarter. Full year 2017 is expected in the range of 2.5% with that expanding to 7.7% next year.

The technical picture did not look very good for this sector at the start of the last earnings season and it does not look to good now. The ETF has trend sideways to down in the past three months, as expected, and looks like it could be setting up for another move lower. It is trading beneath the bottom of the short term trading range following a bearish crossover of the short and long moving averages with mixed indicators. The indicators may be signaling support through divergence, or they may be set up for a new bearish crossover, it just depends on the market now. Considering that there are 7 sectors with better outlook I am leaning toward the the latter. The only thing keeping me from going bearish is positive outlook, I am neutral on this one.


The Utilities Sector (XLU)

The Utilities Sector is expected to post a larger decline in earnings this season than last but also to emerge from its earnings slump by the end of the year. This quarter it is expected to post a decline of -2.2% but reverse that to growth of 7.4% in the fourth. Growth is expected to be positive at 2.1% in 2017 and then grow to 4.6% in 2018.

At last look I was neutral on the sector and that turned out to be wrong. The XLU completed a bounce from the long term moving average and moved up to set a new all time high. Since hitting that peak the sector has moved back down to retest support at the long term moving average and is now setting up to move up to retest resistance. The indicators are both rolling into strong trend following signals with potential target at the current all time high. The only caveat is that there is some nearer term resistance just above current levels, near $54. A break above that would be bullish with upside target near $56. I am cautiously bullish


The Real Estate Sector (XLRE) The Real Estate sector is expected to post positive earnings growth for the quarter, the year and next year. Quarterly growth is estimated at 6.8%, 2017 at 5.3% and 2018 at 6.6%. While estimates for the current quarter and full year have improved those further out have been under pressure. While it is not the strongest performer in terms of expectations, it is expected to post steady earnings growth over the next 5 quarters and pays above average dividend yield which may help keep longer term investors interested.

The chart of the Real Estate Sector SPDR XLRE has been range bound and volatile since it was spun off the financials. The last time I looked at it I was neutral leaning toward bullish due to earnings and potential for range bound trading. The ETF is still trading within its range but that range is an upward channel that appears to be in play. The ETF is trading at support along the bottom of the channel, just above the long term moving average, with indicators in support of higher prices. Both MACD and stochastic are firing trend following so I am cautiously bullish.


The Materials Sector (XLB)

The Materials sector is still expected to be one of the strongest performers over the next 5 quarters. The sector is expected to post only middling earnings growth this quarter but have that expand to 2nd best next quarter, for the full year and next year. Fourth quarter growth is expected at 27.5%, full year 2017 at 23.5% and full year 2018 at 16.1%. The wild card is Trumponomics, as it has been over the past year. The sector is expected to do well on current conditions, it should do better if pro-growth policy becomes a reality but those pro-growth dreams appear to be mired in the Washington political machine.

I was cautiously bullish on the sector last season and, after a brief pop and dip to support, it managed to rally to new all time highs. The ETF is now trading at new all time highs with two caveats; the indicators are both consistent with a peak within the uptrend, and showing divergence from the new high. I am firmly bullish long term but cautiously bullish for the near. A move lower could indicate correction with downside targets near $56.50, about -2%. A consolidation or move higher from current levels is bullish and trend following with upside target near $60 in the near term.


Information Technology

The Information Technology sector has been one of the best performing over the past few quarters and is expected to be one of the strongest performing sectors over the next 5. The sector is coming off of double digit earnings growth and expected to continue posting double digit growth into the end of next year at least. The current quarter is the weakest, only expecting to see growth of 8.8%, but still among the 4 best performing sectors for the cycle. What's also noteworthy is that 4th quarter estimate is up over the last 30 days, as is full year 2018.

Since last quarter the XLK Technology Sector SPDR trend sideways until testing support along the long term moving average, at which time it surged more than 6%. The ETF is now trading just below its current all time high and setting up for the next move. Considering growth is expected to be so strong I see the next move as a leg higher with the caveat of possible consolidation/correction beforehand. The indicators are both consistent with a peak within the uptrend and divergent from the high, suggesting a consolidation will occur which leads me to caution. A fall from this level may find support near $70 and the short term moving average, and would be a likely entry point for new bullish positions provided outlook remains positive. A move higher will be bullish and trend following with target near $76 in the near to short term. Cautiously bullish.


The Financial Sector (XLF)

The financial sector is expected to be a top three performer over the next 16 months with the exception of this quarter. This quarter it is expected to post the largest earnings decline of any sector. This dreadful fact may however be a blessing in disguise as it could induce a buying opportunity. Beginning next quarter growth expectation jumps to +15.4% and is expected to average 14.2% for all of 2018. This growth is driven by my favorite things; labor market trends, wage growth and improving consumer sentiment and could expand above expectations if only one of several triggers are met. These include expanding economic growth, tightening labor markets and tax reform.

Last quarter I was bullish on this ETF with a possibility it would remain range bound and pull back to support targets. Resistance was at the all time high and on the verge of being tested. The test failed, possibly due to deteriorating outlook for the 3rd quarter, and resulted in retreat to my target at $24 and the long term up trend line. It has since consolidated at that support and rallied to new highs. It is now trading at new all time highs with a possibility of consolidating or pull back. The indicators are strongly bullish but consistent with a peak which suggests some form of consolidation or pull back. Targets for support are $26 and $25.50 if it does decide to move lower. If not, a move higher from this level would be bullish and trend following with upside target near $27.50 in the near to short term. I am cautiously bullish.


My Conclusion

I am still bullish on the broad market although, as usual, there are still some sectors doing better than others. On a sector basis I am bullish or cautiously bullish on 9 of the 11 S&P 500 sectors and bearish on none. With earnings outlook as robust as it is I just see no reason for serious selling except on a case by case basis as we have been seeing over the past year or so. My word of caution is that many sectors have already seen a big run up in prices as we approach the season and are ripe for profit taking, consolidation, rotation and correction. If this happens I would view it as an equally ripe opportunity for new bullish positions.

The two sectors I am neutral on, telecom and consumer staples, aren't really expected to do poorly just not very well. In today's environment with so many expected to do well there are much better opportunities.

Of the sectors I am bullish on the ones I am most bullish on are Energy, the Industrials, the Financials and Technology. With the exception of the industrials they are all expected to see double digit earnings growth this year and next with the possibility of that growth exceeding expectations. My misgivings about the charts may turn out to be nothing but it's better to be cautious than lose money unnecessarily. Regardless the outcome stronger signals will come. I am happy to tighten my stops for now, and get ready for earnings season. It's almost here.

Until then, remember the trend.

Thomas Hughes