There is a trifecta of positive earnings oriented catalysts driving equities in the New Year. The Q4 2017 earnings cycle is upon us and things are looking good. Not only are we looking for positive earnings, there is growth in the forecasts and the estimates are on the rise. The point that makes this quarter's cycle different from those of the past 2 years is this; estimates are on the rise.
Up to now market gains were supported by earnings growth and expansionary outlook but those gains were capped by chronically declining estimates. Although outlook was positive it became less and less positive as the cycle approached. The only good thing about that is it did provide opportunity for a broad spectrum of stocks to beat estimates.
A look at the table below illustrates this. Estimates for the 3rd quarter fell in the weeks leading up to the start of the reporting cycle, hitting their low just before peak season. Actual results for the quarter were much better than expected resulting in a not unexpected increase in earnings growth of 4.4% by the end of the cycle.
Fourth quarter estimates are trending in a similar fashion but have not seen the same amount of decline as in previous cycles. Third quarter 2017 estimates fell 75% from their peak before bottoming while fourth quarter estimates have fallen only 17% in the comparable period. This may mean that earnings may not beat by as large a margin as they have over the past 8 quarters, or that earnings growth will be truly robust this time around.
So far about 5% of the index has reported for the 4th quarter. Of those 78% have beaten on the revenue side of the equation. This is in line with last quarter's rate of revenue beats but above the 4 year average. About 95% of those reporting have beaten earnings estimates which is well above the 4 year average and suggests growth will indeed be above expectations in this cycle.
Looking forward growth is expected to continue into the end of this year at least. Not only that, with the combined tailwinds of economic growth and tax reform, estimates are on the rise. All four quarter of 2018 have seen at least a 1.5% increase in earnings growth estimates in the last 2 week's. The first half is now expected to see growth in the range of 12.25% with expansion to 13.5% in the second. This brings the full year 2018 estimate up to 13.1% and it will likely go higher. We've only seen the first round of revisions, I expect to see more of the same over the course of the next 4-6 week's.
Of the 11 S&P 500 sectors all 11 are expected to grow. Once again energy is expected to lead although growth this year will be a fraction of what it was last year. Full year growth in the energy sector is expected to be triple digits in 2017 and is already there; that growth will moderate to about 40% in 2018 but those estimates are on the rise. After that materials, info tech and utilities are all expected to see double digit growth this quarter.
The S&P 500 Technical Outlook
The S&P 500 has been in up trend since the last earnings cycle update. The weekly chart shows an index that is still in up trend and likely to go higher. Both the stochastic and MACD are bullish and showing strength consistent with higher prices. Stochastic has just fired a bullish crossover in confirmation of new highs while MACD is peaking convergent with those highs, both consistent with a rising market. I admit the chart looks extended but I can't argue with the indicators and economic/earnings trends do support rising prices. My current target is near 2,800.
The daily chart is similarly bullish. The index has been and is marching to new highs on a weekly if not daily basis. The indicators are both showing bullish crossovers in line with the prevailing trend and consistent with higher prices. The MACD peak is not overly large but is larger than any in the past 18 months, convergent with the new all time highs and suggests underlying strength in the broad market.
Fourth 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 will dominate in 2018 as well. The sector is expected to post growth in the range of 130% and those estimates have bee on the rise in tandem with oil rise to multiyear highs. Considering the fact that WTI is hitting new highs above $62 as I write this I venture a guess that forward estimates will be rising as well. Looking forward growth is expected to moderate in 2018 but to what I would still call robust levels, about 42%. Based on the oil price forecast from the EIA and IEA I'd venture a guess that growth will be stronger in the first half of the year and weaker in the second. According to both forecasts the average price for WTI in 2018 will be close to $52, well below today's prices.
At last look the XLE Energy SPDR was completing a reversal pattern and setting up to move higher. My target of $74 was reached in just the last week and likely not the the end to the rally. The indicators are showing a bit of near term weakness that may lead to consolidation but are otherwise strongly bullish and indicative of rising prices. Convergences exist in both the stochastic and MACD that suggest current highs will be retested or exceeded should a consolidation or correction occur. Regardless, the trend is up and supported by earnings outlook my own reservations notwithstanding. I am bullish on this sector near and short with some concern for the long. Upside target is just above $78 and near the 14 month high.
The Materials Sector (XLB)
The Materials sector is expected to be the 2nd strongest performer in the 4th quarter and full year 2017, and the third best in 2018. Earnings growth it estimated in the high double digits for all three periods and is supported by global expansion. Along with the positive outlook are a recent round of upgrades for all the quarter, the year and next year that are driven by signs of economic acceleration and Trump's pledge to tackle infrastructure in 2018.
I was cautiously bullish on this sector the last time around and that was a good call. The indicators were consistent with correction on the XLB Materials Sector SPDR and one did in fact develop. It did not result in as deep a move as I estimated but did result in a bounce, continuation of trend and new all time highs. My target was exceeded and current analysis is bullish. The ETF appears to be peaking within an uptrend but the indicators are both strong, MACD is at an extreme peak, and consistent with rising prices. I am bullish on this sector.
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 strongest, growth is expected to moderate into the end of next year but remain strong at 13.3% for all of 2018. In terms of estimates they are on the rise for the current cycle and all of 2018.
At last look I was cautiously bullish on this sector but that caution was unfounded; no correction developed in the XLK Technology Select SPDR. The ETF bounced from its moving average and moved to new highs driven by rising chip sales and the success of FAANG and other tech giants. The ETF is still trending higher and is currently in mid-bounce. The bounce is from the short term moving average and supported by the indicators. Both MACD and stochastic are bullish and moving higher following a bullish crossover and consistent with a trend following move higher. It is now trading at new all time highs with targets in the range of $70. I am bullish on this sector.
The Utilities Sector (XLU)
The Utilities Sector is expected to emerge from its earnings slump this quarter with growth of 11.7%. That being said full year 2017 is still going to be weak at 2.3% and while full year 2018 will grow on that it will not grow much. Full year 2018 estimates call for growth in the range of 4.8% which means this cycles pop to 11.7% is likely a peak that won't be breached in the next year. In the near term estimates for the current cycle are on the rise and could drive it higher.
At last look the XLU Utilities SPDR was setting up for a trend following bounce from its short term moving average. This move was supported by forward earnings growth outlook with target at $56. This target was reached and exceeded although the high hit in early November turned out to be a top. The ETF is now moving lower on tepid earnings outlook and increased risk-on appetite in other sectors. The indicators are bearish but suggest a support level has been reached. A move higher would not be bullish but more likely set the ETF for another fall. Resistance is near $54 and the pair of moving averages which are showing a bearish crossover. A move below $51.50 would be bearish and could take the ETF down to $48 or lower. I'm neutral on this sector.
The Financial Sector (XLF)
The financial sector is expected to be a top five performer this cycle and for the full year 2017 and be a top 2 performer for all of 2018. Current estimates call for earnings growth in the range of 9.5% for the 4th quarter, 6.4% for the year, and then expand to nearly 20% in 2018. This growth is driven by my favorite things; economic expansion, labor markets, wage growth, improving consumer sentiment. At last look I suggested growth could begin to expand above expectations if only one of several triggers are met. Those include expanding economic growth, tightening labor markets and tax reform; all three of which have happened over the past quarter.
The XLF Financial Sector SPDR has been trending up over the past 12 months and more as the US economy slowly recovers. Last quarter I was cautiously bullish on the sector with a target at $27.50 and that target was exceeded. The ETF is now breaking out of consolidation to the upside with an eye on setting new highs. The indicators are both firing bullish crossovers in confirmation of the move and consistent with higher prices. I am bullish on this sector.
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 5.0% with full year 2017 at 2.5%, both of these estimates have fallen in recent weeks. Looking forward growth is expected to expand to 8.5% in 2018 but is still tepid compared to 20% in the financials and 18% in materials.
I was neutral on this sector last cycle and looking for the XLP Consumer Staples SPDR to trend sideways within a range. Support was tested and has, in recent weeks, led to a bounce and move up to test resistance. The ETF is now consolidating just below the all times and looks like it could move higher. The indicators are still a bit mixed but rolling in to a bullish trend following signal that is yet to be confirmed by MACD. A move up to new highs would be bullish with targets at $59 and $61.
The Healthcare Sector (XLV)
The Healthcare Sector has not been my favorite for some time and that really hasn't changed. Political risk is abundant but one thing remains clear, the industry makes a lot of money and it is getting bigger every day. It is expected to post growth for the 4th quarter but estimates have been falling. Full year 2017 is looking it will show growth of 5.9%, up a bit in recent weeks. Looking to next year growth is expected in the range of 7.3%.
At last look I was cautiously bullish on the sector looking for a possible pull back in the XLV Health Care SPDR to $81 and/or break of resistance near $84; both of which happened. The ETF is now in a continuation of its uptrend and breaking to new highs. The indicators are both bullish, pointing higher and consistent with rising prices with targets near $89 in the near term.
The Real Estate Sector (XLRE)
The Real Estate sector is expected to post positive earnings growth for the quarter but it is one of the poorest performers in terms of expectations, estimates have been falling and forward outlook isn't that great either. Outlook is positive, full year 2018 is estimated to produce 6.3% growth but that estimates as also been falling. On the bright side tax reform and economic expansion should support the sector going forward, just not as well it is supporting other areas of the economy.
At last glance I was cautiously bullish on the sector and the XLRE Real Estate SPDR. It had been trending upward within a range and that range continued as expected. The ETF is now back at the bottom of the channel and indicated lower in the near term. Support is near $32 and may be tested. A break through would be bearish but is not expected. A bounce is more likely in light of forward outlook although upside potential may be limited. I am neutral leaning toward cautiously bullish.
Consumer Discretionary (XLY)
The Consumer Discretionary sector finally exit its earnings slump last quarter, barely, and is projected to grow earnings in the current reporting season. Fourth quarter earnings growth is expected to come in at 2.3%, down from a more robust 6.4% earlier in the year. Looking forward growth is expected to expand to robust levels in 2018 and average 10.2% by the end of the year.
At last look I was cautiously bullish on the sector due to positive forward outlook, positive consumer trends and bullish technicals. My target for the XLY Consumer Discretionary SPDR was $96 and that target was exceeded. The ETF has been in a strong rally over the past month and is now trading at new all time highs. The indicators are bullish and in support of higher prices although momentum has been weakening as price powers higher. I am cautiously bullish.
The Industrial Sector (XLI)
The Industrial sector is expected to show earnings growth for the 3rd quarter in a row although that grow will be very weak. Sector estimates have fallen the sharpest of any, down to 1.7% from 10.1% at the end of September. Full year 2017 is expected to come in around 1.6%, also down in the last month, and then expand to 11.0% in 2018.
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 the XLI Industrial Sector SPDR was gearing up for a move up toward my target of $76. That target was exceeded in recent weeks leaving it at new all time highs. The indicators are bullish and in support of the move although there is some divergence in momentum to be wary of. I am cautiously bullish.
The Telecom Sector (XTL)
The Telecom sector is expected to post the weakest earnings growth of any sector in the 4th quarter of 2017 and for all of 2018. Full year 2017 is expected to close near 1.1%, down from previous estimates, and then expand to a tepid 2.1% in 2018 with little in the way of positive catalysts on the horizon.
I was neutral on the sector last time around on optimism for earnings and made the wrong call. The sector performed poorly once again and did nothing to inspire confidence going forward. The XTL Telecom Sector SPDR trend sideways within its range after dipping to test support at 1 year lows. It is now trading above the pair of moving averages and indicated higher although I am not holding my breath until a big move comes. Longer term this sector is likely to remain range bound. I am neutral.
This is the most bullish I've been on the index in quite some time, and I have been generally bullish on the index for quite some time. There are 8 of 11 sectors with bullish outlook and none with a bearish outlook so no reason for me to expect lower prices on the index. At best, or worst rather, we may see a consolidation or near term correction but that would be a buyable dip in my opinion.
The neutral sectors aren't that bad. They are all expecting growth if weak growth, they just aren't that attractive in light of other sectors with brighter prospects. Of the bullish sectors there are some standouts and those are energy, information tech and materials; all of which are expected to post double digit earnings growth. So long as growth like this in the forecast bullish is all I can be. When that changes so will I.
Until then, remember the trend.