Introduction

The 2nd quarter earnings season has gotten off to a tepid start but expectations remain high. Assuming that nothing unexpected happens this will be the fourth quarter of earnings growth since the market exit the earnings recession last year. Last quarter we had 2 out of 3 factors I like to see working in our favor; earnings growth and expanding growth. This quarter we've only 1 of the 3, earnings growth, although expansion is expected to resume next quarter and continue into next year.


One caveat to be aware of is that forward outlook continues to decline. The silver lining to that cloud is that declines are primarily due to the energy sector. The sector was expected to post ridiculously high 450% earnings growth this year, based on +$50 oil, and those estimates have begun to fall in the wake of the oil price correction.

The blended rate of earnings growth for the S&P 500 is about 6.8% although that is likely to change with reports released this week. This is down substantially from the 1st quarter's 14% and the 10.6% expected for this quarter earlier in the year. However, keep in mind that estimates have been low-balled for the past few years. On average the final rate of earnings growth has been about 4% higher than the blended rate at the start of the reporting season. Looking back at the last quarter the final rate was more than 5% higher. This means we can expect to see the 2nd quarter earnings growth rate rise to a range of 10% to 12%.


Full year 2017 is still expected to be strong. The number has fallen from a high near 14% but still robust at 9.6%. If the averages hold true and the final rate for each quarter comes in about 4% higher than expected the full year figure will rise as well. Perhaps as high as 12% or so. Looking to next year growth will expand again although this estimate has also been falling. Now near 11.6% it was as high as 12% 4 months ago. If nothing else changes and earnings trends remain constant 2018 growth could go as high as 16% by the end of next year.


Looking at the weekly chart of the S&P 500 we can see that the index has gained about 100 points of 4.3% since the last earnings season began. The index has extended the Trump Rally to new all time highs and is approaching targets I set with the last earnings outlook. The index has also fallen below the steep up trend line it has been following which poses the risk of becoming resistance. At current levels the index is extended well above the shallower long term up trend line and the long term moving average. The indicators are divergent from the new highs and consistent with a weakening trend so there is some caution due. If a correction was to begin here downside targets would be the 150 day moving average for a drop of -3.8% and then the up trend line for a drop of -8.5%. That being said the emerging signal is bullish and trend following.


The daily charts agree with the weekly. The index has extended its rally but also showing increasing signs of a weakening trend, no guarantee of correction but nonetheless worrisome. These signs include resistance along the underside of the long term up trend line and divergences in the indicators. If the index were to fall near term targets would be the short term 30 day moving average, -1%, and thenthe longer term 150 day moving average. In either event, if they occur, the long term trend remains up with positive forward earnings outlook so would be considered a possible buying opportunity.


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. 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, above 300%, and still ridiculously high near 350% for the quarter and 255% for the year. Estimates have been declining on falling oil prices but now, with oil prices moving up from support, may begin to stabilize or even rise again. Looking to next year growth falls to 40.8% but is still robust. I've been bullish on the sector with a long term view for quite a while based on this outlook and I remain the same.

At last look the energy sector was beginning to show signs of support. The XLE Energy Sector SPDR was bouncing from the $70 level and targeting resistance at the 150 day moving average. Since then oil prices have corrected to a full -20% from the 2017 high and have pulled the sector down with it. The 150 day EMA was reached but it was not broken, resistance was strong and drove prices down to $65 where they are now showing signs of bottoming. Stochastic never crossed below the lower signal line, a sign of underlying support, and has been trending at that level during the recent down trend. The current signal is up and may soon be confirmed with a switch in momentum, a switch that could be driven by earnings outlook. The ETF may see volatility due to oil price fluctuation but I am bullish long term and getting bullish near term. No bottom yet but there is a chance for relief rally with upside target near $68 in the near to short term. Cautiously bullish.


The Industrial Sector (XLI)

The Industrial sector is expected to show earnings growth this quarter. Current expectation is 2.5% for the quarter and 6.4% for the year, both estimates on the rise since the end of the quarter. Since 1st quarter growth was negative and 2nd quarter growth is only 2.5% 3rd and 4th quarter growth will need to be above 6.5% to meet full year expectations. This tailwind, added to next year's projected 11.8% growth rate, should provide some lift for the sector.

This sector has moved higher since last look, in line with expectations. The Industrial Sector SPDR has risen a little more than 6% in that time and trading at the all time high. The indicators remain bullish and in support of higher prices although there is a red flag. MACD momentum is divergent from the high and may indicate weakness. That being said the near, short and long term trend is up and supported by the indicators and the earnings outlook so I am bullish on this one.


The Telecom Sector (XTL)

The Telecom sector is expected to return to growth this quarter but the expectations are not good. The sector is projected to grow earnings for the quarter by only 0.8% while full year outlook has turned negative. At last look full year 2017 was projected at 0.5% with a risk of turning negative, this time it is coming in at -1.5% and at risk of falling further. Full year 2018 remains positive but has fallen as well, shrinking by nearly 50% to 2.4%.

I was cautiously bearish on the sector last quarter and the cautious part at least was right. The sector spiked on earnings surprises but has since fallen on earnings realities. The Telecom Sector SPDR XTLh has trend sideways for the last 3 months and remains within that range. The ETF is now at the bottom of the range but the indicators point to a continuation of the range rather than a break to the down side. Support is currently at the 150 day moving average near $70, a break of which may find additional support near $69. I am neutral and leaning bearish, a break support may change my mind to more firmly bearish. The mitigating factor which may keep the ETF and sector above support levels is the dividend. XTL itself is only yielding about 1.5%, underlying stocks pay much better.


Consumer Discretionary (XLY)

The Consumer Discretionary sector is expected to post the largest negative growth of the few sectors with shrinking earnings this quarter, -2.0%. Looking forward the sector is expected to return to growth as early as next quarter with that growth expanding to nearly 12.5% next year. While consumer spending remains tame labor markets are tightening, unemployment is low and wages are rising which will all lead to accelerated spending sooner or later.

Technical outlook for the sector at last look was cautiously bullish. Since then the Consumer Discretionary Sector SPDR completed a near term consolidation and bounced higher from the long term up trend line. Most recently the ETF hit a new all time high and corrected from there. It is now moving up from potential support and within 2.5% of the high. The indicators are not promising, both remain bearish although they are both also showing signs of a bounce from support. Upside target is currently the all time high, more than that will depend on results and outlook. A break above will be bullish with upside target near $115 in the long term. Failing to break resistance will be bearish in the near term with downside target near $87.75 and the 150 day moving average. 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 abundant but one thing is clear, the industry makes a lot of money and is getting bigger every day. Current outlook is fairly weak but positive, 0.5% for the 2nd quarter. Looking forward growth expands in tandem with the broader market but at an average pace only. Full year growth is expected to be 4.6% for 2017 and then expand to 9.2% in 2018.

Last quarter the Healthcare SPDR XLV was moving higher with the expectation of testing resistance. The ETF did indeed test resistance and then it broke through. It is currently trading just shy of the all time high and in consolidation. Price action is forming a possible flag pattern with bullish outlook. The caveat is the indicators which are both diverging from the high and suggestive of a peak or false break out. The next move will come down to earnings and outlook. Cautiously bullish.


Consumer Staples

The Consumer Staples sector is still expected to post growth for the quarter but those expectations are much lower than a few months ago. The sector is now projected to post earnings growth of 3.2% for the quarter and 3.6% for the year. This will grow to 7.7% next year but still not great compared to other sectors of the market.

Despite the positive earnings projections technical outlook for the sector is middling at best. At last look outlook was bullish and the Consumer Staples Sector SPDR did indeed pop. The ETF broke resistance to gain 5% and set a new all time high, the bad news is that the high did not hold. Divergences formed in both indicators that have resulted in bearish crossovers and lower prices. They are both moving lower in support of even lower prices although a break of the short term moving average would be required. If that happens a downside target of $51.75 comes into play. While the near term looks bearish the short and long term remain bullish as does earnings outlook so I am bullish long term. Near term I am cautiously bearish with an eye for buying the dip if and when price action returns to trend.


The Utilities Sector (XLU)

The Utilities Sector is expected to post a small decline in earnings this quarter, -0.2%. This is better than the -0.3% expected earlier in the year but not much. Full year expectations have risen as well and are now at least positive at 0.2%. Looking out to next year growth continues and is expected in the range of 6.1%.

The chart of the Utilities Sector SPDR was not overly bullish last quarter and it is not very bullish this time around either. In that time the XLU Utilities Sector SPDR has spiked to a new high but the move has turned out to be whipsaw. Price action has fallen back below resistance with weak indicators and is in danger of moving lower. Price action is bouncing from support at $51.50 but not strongly. Resistance is just above at the $53 level and would need to be broken for a more bullish stance. Neutral.


The Real Estate Sector (XLRE)

The Real Estate sector is expected to post average earnings growth for the quarter, the year and next year. Quarterly growth is estimated at 3.7%, 2017 at 3.9% and 2018 at 7.2%. While it is not the strongest performer in terms of expectations it is expected to post steady earnings growth over the next 18 months along with an above average dividend yield.

The chart of the Real Estate Sector SPDR XLRE has been range bound and volatile since it was spun off the financials. The last two times I've looked at it going into earnings it did not look bullish and it still doesn't today. The ETF is still trading within its range with indicators showing no sign of directional movement. Earnings and the dividend may attract support but I see no reason to get overly bullish here, I am neutral leaning toward bullish.


The Materials Sector (XLB)

The Materials sector is expected to post earnings growth of 4.7% this quarter with expansion in the forecast. Full year 2017 is projected to come in around 13% and hold steady into next year. Looking forward full year 2018 estimates have been on the rise and are up nearly 2% over the past 3 months. 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. The question now is if Trump will ever get anything done.

Earnings outlook for the Materials SPDR XLB is bullish and the ETF is trading at a freshly set all time high. The indicators are bullish so the current run is likely to continue although there are some red flags. Both stochastic and MACD are showing divergences which suggest some underlying weakness in the market. With the index 4.5% above the 150 day moving average the is room for correction however bullish the outlook. Near short and long term trends remain intact so I am bullish, just a bit cautious. Cautiously bullish.


Information Technology

The Information Technology sector is expected to be one of the strongest performing sectors over the next 6 quarters. 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 2nd quarter estimate is 10.5% and has been holding steady. Full year 2017 is projected to be 10.7% with that expanding to 11.5% earnings growth next year.

I was bullish on the sector last quarter and I am bullish on it now. The sector is being driven by strong earnings growth and outlook with the only caveat the possibility growth is already factored into current prices. Since last quarter the XLK Technology Sector SPDR has surged more than 7% following the flag pattern I detailed last time. Over the past 8 weeks the ETF has been in consolidation and is now bouncing from support. The indicators are rolling into a trend following signal with only the resistance of the current all time high standing in the way. I am bullish on this sector.


The Financial Sector (XLF)

The financial sector is expected to be a top three performer over the next 2 years. The sector is expected to post growth of 8.2% this quarter, 11.2% for the year and 12.6% next year. Growth is being supported by improving labor markets, improving consumer trends, improving economic conditions and Trumps pro-growth agenda. Rising interest rates are also expected to help boost revenue and earnings but the impact from that has lessened in recent weeks. Most of the major players in the sector have already reported and the results are mostly positive. Revenue and earnings are on the rise with some isolated weaknesses on a company to company basis.

Last quarter I was cautiously bullish on the sector, since then the Financial Sector SPDR XLF has risen 9%. The ETF hit resistance at the post-financial crisis highs set earlier this year and is now trading just beneath it. The indicators are bullish and consistent with higher prices so I would expect to see the high tested again at least. A break to new highs would be bullish with upside target near $27 in the near to short term. Failing to break to new highs may result in a pull back to support with targets at $24 and $23. A move below $23 would be bearish but not likely given the circumstances. I am bullish on this sector.


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 7 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.

The four sectors I'm neutral on aren't expected to perform poorly, just not as well as the general run of stocks. The Telecom sector is looking to see earnings decline on a year over year basis, not much but any amount is too much when other sectors are seeing double digit growth. The Real Estate sector may in fact be moving higher, earnings projections are positive and expand into next year, but the volatility is too much for me to be comfortable with when other less volatile sectors are expected to do so much better. The other two, Utilities and Consumer Staples, are also both looking forward to growth but just not as much as the market leaders.

Of the sectors I am bullish on the ones I am most bullish on are the Industrials, the Financials and Technology. This is mostly because of forward earnings outlook, technical set ups are trend following but weak in every case. On the earnings front 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.

Until then, remember the trend.

Thomas Hughes