Earnings Growth Expands Accelerates In Q1 Earnings season is upon us once again, this time around earnings growth expands with positive forward outlook.

Introduction

Earnings season is upon us once again and if all goes as expected will be the third quarter of positive growth, the third quarter of expanding growth and the fastest pace of growth since Q4 2011. As always, this quarters results will set the tone for the next 3 to 6 months of trading and, if forward estimates are on target, the beginning of an extended period of earnings growth. I've mentioned in the daily wraps we've got 2 of 3 positive elements working in our favor; earnings growth and expanding earnings growth. The one element that may weigh on sentiment is the fact that estimates have been falling. When this changes everything will be in place for a long term earnings driven bull market.


Another caveat is that 2nd quarter and 3rd quarter expansion is expected to cool off a bit before accelerating again in the 4th quarter. This may affect near and short-term market direction but should not impact the long term trend.

Q1 earnings growth is expected to be in the range of 9%. This is down from a high of 12% but has stabilized and begun to rise since the first reports of the quarter. So far about 5% of the index has reported, the big names begin reporting next week and the week after reporting begins in earnest. Over the past 2 years, due to low-ball estimations, the index as a whole has been able to beat on both the top and bottom lines. Based on the averages we can expect to see the final rate of earnings growth come in above 10% and possibly as high as 13%.


Full year 2017 is still expected to be strong at nearly 10%. Looking forward to next year this growth is expected to continue on a quarter-to-quarter and year-to-year basis at least to the end of 2018.


Full year 2017 estimates have been falling along with the quarterly estimates. This number may decline further is forward estimates continue to fall. The mitigating factor is that final growth rates for each quarter are expected to rise from beginning of season to end. This means that sometime toward the end of the year the FY2017 growth estimate will bottom and begin to rise as it did last year. If forward quarterly estimates begin to improve, possibly due to guidance provided this quarter, the full year rate will begin creeping higher sooner.


Looking now at the weekly chart of SPX prices we can see that the index has risen 130 points since the end of last year and the onset of Q4 earnings season. The SPX was able to to extend its breakout from the 2015-2016 trading range and is approaching the upper target. The trading range has a magnitude of about 325 points which puts upper target for this move above 2,400 and approaching 2,500. The move has been aided by the Trump election which helped spark a rally that had been brewing for many months, if not years. The last 6 weeks or so has seen the index consolidate near the newly set all-time highs and bounce from a long-term trend line. The trend-line is on the steep side so carries a little more risk as a signal but it is grounded in past price action. It began with a bounce from the bottom of the 2015-2016 trading range, confirms another less-steep long-term trend line and then reconfirms again on the break-out of the range.


The technical outlook for the index is bullish in the long and short-term but cautious in the near. The indicators are consistent with topping/consolidation action and have not yet reconfirmed the bull market. This may lead to additional testing of support along the trend-line or, if broken, along near-term support levels in the 2,325 range. A break down below those level may indicate a deeper correction. However, with earnings growth on tap I don't see that happening without some external influence such as geo-political tensions.

Fourth Quarter Earnings By Sector

The Energy Sector (XLE)

The biggest story in earnings over the past 6 or 7 quarters has been the energy sector. It was the leading cause of the earnings recession and will do the same thing during the earnings recovery. Earnings growth expectations for the sector are astronomically high, above 300%, and are driven by rising oil prices. There was some concern over the past month that prices would fall, I still think they will, but for now they have bounced back and moving up to resistance levels near $55 for WTI. Full year growth is projected at 300% and then moderates to only 45% growth in 2018. The decline from 300% to 45% is a big one but I think I will consider 45% bullish for the sector nonetheless.

The energy sector has been gyrating on oil prices recently, pulling back to test long-term support, and has begun to bounce. The Energy Sector SPDR XLE has retreat back to the $70 level and showing early signs of bouncing. This level is consistent with last October's peak, a recent consolidation range and a break of resistance. The indicators are still weak but also showing early signs of bullishness. Stochastic is making a weak bullish crossover while MACD is rolling into a potential bullish crossover, consistent with a bounce from support but not quite enough to indicate reversal. If the bounce does continue the ETF will face resistance at the 150 day EMA. A move above there would be bullish with upside target near $80.


The Industrial Sector (XLI)

The Industrial sector is expected to post the largest decline in earnings growth this quarter, -7%. This estimate has been falling and is down from 0.5% at the start of the quarter. Full year 2017 is expected to turn positive with strength towards the end of the year. Next year should see growth continue to expand, full year estimate for 2018 is near 12%, and the third highest for the year.

The chart is generally bullish in the long and short term with signs of weakness in the near. The set up is very similar to that of the broader market. A long term rally, with multiple bounces and confirmations, has produced all-time highs and set the ETF for a trend following bounce. It is still a bit above the trend line, and with negative growth expected this quarter and maybe next, consolidation could easily continue in the nearer term before upward movement resumes. Cautiously bullish.


The Telecom Sector (XTL)

The Telecom sector is expected to post the second largest decline in quarterly earnings of any sector this cycle, -2.7%. Looking forward the picture is rosier but not as good as it was a quarter ago. The sector is expected to post positive earnings for 2017, 0.5%, although estimates have been falling and this could turn negative very easily. Farther out in 2018 growth is expected to expand to about 4%, the slowest rate for any sector all year.

"The chart of the Telecom Sector SPDR XTL is scary looking, if you're a bull." Those were my words last go round and they stand true today. The sector did not decline in the last 3 months but while others were consolidating this one appears to be making a reversal. Price action could easily turn into a Head & Shoulders, all it will take is a break of the trend-line. The indicators persist in weakening following a wicked divergence in the stochastic, not a sure sign of reversal but one that should not be ignored. A break below support near $69 will be bearish for the near-term at least, with downside target of $65. Cautiously bearish.


Consumer Discretionary

The Consumer Discretionary sector is expected to post the smallest amount of negative earnings growth, about -1.8%. This is down significantly from the beginning of the quarter when analysts had been expecting positive growth in the range of 6%. Full year 2017 is expected to be positive at 5.6% with that accelerating next year. Full year 2018 growth expands to about 12% and is expected to be the 2nd strongest sector. Automobiles may be the one segment to suffer if the last read on car/truck sales is any indication.

Earnings outlook is neutral in the near-term, -1.8% isn't much and could easily be erased by end of season. Longer term outlook is positive and that is evident in the charts. The sector broke out of a long term range at the beginning of the year, along with the broader market, and it is trending higher. The indicators are mixed in that they both show strength in the longer term but nearer term are bearish and indicate a potential peak. This may indicate consolidation until forward earnings outlook is more firmly positive. A break of the uptrend line would be bearish but may only result in sideways trading, near term support target is $85.50. Cautiously bullish.


The Healthcare Sector (XLV)

The Healthcare Sector is still not my favorite. In terms of earnings growth outlook the sector looks good and is expected to post expanding earnings growth into the end of next year. The problem is too much risk with Obamacare and the repeal/replace for me to be comfortable. This quarter, earnings are expected to grow by 0.5% with full year 2017 coming in around 4.2%. Looking out to next year growth expands to about 9.2%, near the mid-point of the 2018 range.

Last quarter I described the XLV Healthcare SPDR as an ETF winding up with no idea where it was going next. It had been trading in a tightening range, near the middle of a longer term range, with mixed indications. Since then it did move higher, along with the broader market, but did not even come close to breaking out to a new high. Until that happens it will remain range bound with upper resistance near $77.50, about 4% above today's prices. Neutral.


Consumer Staples

The Consumer Staples sector is expected to post the second smallest increase in earnings this quarter, about 1.6%. Estimates have fallen from the first of the quarter and have resulted in a decline for full year outlook as well. Full year 2017 is now expected to come in around 4.2% and then expand to near 8% in 2018. While the sector looks solid in terms of earnings it is only average when compared to the rest of the sectors. The silver lining is that the sector is firmly supported by labor trends, household creation and a strengthening consumer.

Despite the only middling forecast for earnings growth the technical forecast for the Consumer Staples SPDR XLP is bullish. The weekly charts shows an ETF that has consolidated within an uptrend, retreat to test support and has bounced from that support. It is now forming a potential flag pattern and consolidation with an upside target of $60. The indicators are consistent with a consolidation within an uptrend but have not yet confirmed additional upside. A break above $55.50 would be bullish. Bullish.


The Utilities Sector (XLU)

The Utilities Sector is coming off a great quarter and year, and not expected to perform as well this year. The sector posted the 2nd largest earnings increase last year, 9.6%, and is expected to show the slowest growth this year. The first quarter will not be too bad, positive growth is expected in the range of 2.8%. Looking beyond that growth will turn negative by the end of the year. Full year 2017 is expected to be -0.7% with positive growth returning in 2018.

The chart of the Utilities Sector SPDR is not overly bullish. The ETF is trading near the top of a long-term trading range with tepid earnings outlook. The indicators are bullish but have begun to roll over, consistent with the top of a trading range. Resistance is at $52 and may be tested again however my near to short-term assessment is bearish. Longer term earnings growth and steady dividends will likely draw support. Downside target is near the bottom of the range with possible support at $50, $48 and $47. Neutral.


The Real Estate Sector (XLRE)

The Real Estate sector is expected to post the 4th largest increase in earnings growth this quarter, versus the 4th largest decline as it did last quarter. Growth is expected to come in around 6.7%, more than double the utilities, but is still tepid compared to other sectors this quarter. Full year 2017 is only expected to be about 4% which means growth will slow later in the year before picking back up again next year.

The chart of the Real Estate Sector SPDR XLRE did not look bullish last quarter and it does not look bullish now. The sector has only been spun off the financials for about 18 months and it still looks like it is trying to find its equilibrium. The indicators are weakly bullish so it may be on the way up to test for resistance again, earnings growth and the possibility of better than expected earnings growth could support such a move. Short to long-term the ETF is likely to remain inside its range with the possibility of moving higher into the end of the year. Cautiously bullish.


The Materials Sector (XLB)

The Materials sector is expected to post double digit earnings growth this quarter, this year and next year. First quarter earnings growth should be around 10.6% and expand into the end of the year. Full year growth is expected to be near 13% and then moderate to only 11% next year. The wild card is Trumponomics. The sector is expected to do well on current conditions, it should do better if pro-growth policy becomes a reality.

Earnings outlook for the Materials SPDR XLB is bullish and the ETF is consolidating at all-time high levels. Over the last quarter the sector has moved up from support, broken to new highs and then held those highs for nearly 3 months. The indicators have rolled over, consistent with the consolidation/congestion band, and set up for bullish trend following entry. Firm near-term support is just above the 150 day moving average, near $51, and may possibly be tested again although the previous all-time high is serving as support now. A move up from this level would be bullish. Bullish.


Information Technology

The Information Technology sector is expected to post the 4th largest increase in earnings growth this year. The negative factor is that growth will decline from a high of 13.4% this quarter to below 9.6% by the end of the year. Next year growth is expected to expand again, to 11.3%, to be in-line with the broader market. These estimates may be low, I've heard several reports of increased demand for chips which may indicated increased activity in the sector, or within a segment.

Last quarter I was cautiously bullish on the sector, thinking it may have hit a peak, but I was too cautious. The sector blew right on up to set new all-time highs and looks like it is going to keep on running higher. Price action over the past few weeks has been consolidation within an a strong rally that has the looks of a flag formation. The indicators are consistent with a consolidation within an uptrend but have not yet confirmed continuation. A move to new highs would be bullish with a long-term target near $59. Bullish.


The Financial Sector (XLF)

The financial sector is expected to be a top shelf performer over the next 2 years. The sector is expected to post growth of 14.8% this quarter, 11.9% for the year and 12.6% next year. This puts it in the top four spots in all periods. Growth is being supported by improving labor markets, improving consumer trends, improving economic conditions and the pro-growth agenda. Rising interest rates are expected to help boost revenue and earnings as well.

The XLF surged to a new high after the first of the year but has since fallen back to support levels. The ETF is in uptrend although recent action does not look overly bullish. The indicators too are falling off, indicative of some weakness, but these may be false signals. The way earnings growth is expected I just can't see this one selling off too sharply unless something were to provoke it. Support is near $23, short term resistance near $24, with a break above that facing additional resistance at the current all-time high. Cautiously bullish.


My Conclusion

I am bullish on the broad market although there are certainly areas of expected strength and weakness. I'm not bearish on a single sector this time around but there are a couple I'm not to keen on. Healthcare of course is just a sector that I choose to avoid, so I am neutral on it. I'm neutral on the Utilities as well, I think declining earnings will weigh on prices until support is reached, how low that will be is yet to be seen. Of the rest I am cautiously bullish on 5 sectors and bullish on 4. All we need now is for the season to start.

The four sectors I'm bullish on; energy, consumer staples, materials and information technology. Of those I'm most bullish on the materials XLB and information technology XLK for two reasons. Earnings outlook and the charts. The earnings outlook is solid for both with the potential for double digits both this year and next. Add to that the fact they are both trading and consolidating at all-time highs makes them more attractive. Of the two the XLK, information technology, looks the most bullish to me.

The daily chart shows it bouncing off the short-term moving average with indicators in confirmation of support. Stochastic %D is moving higher, in-line with the prevailing trend, with %K moving below and setting up for a trend following swing. MACD is also set up for a trend following swing having made a low and then a higher low in confirmation of support. All it needs now is the spark to drive prices higher and that may come in the next few weeks. Next week the big banks kick off the season but it will be another week until we get any substantial amount of reporting.


Until then, remember the trend.