Introduction

I began my last earnings cycle update with the sentence "A lot has happened since the end of the last earnings cycle," and nothing is truer today. A lot has happened since the last earnings cycle the primary of which is the trade war. The constant back-and-forth between Trump and our trading partners, the endless false-starts and back-peddling by the administration has kept the market on its toes.

Regardless of the fear, long-term fundamentals are firmly skewed in favor of bull market conditions. On the economic front, growth is accelerating broadly and supported by robust labor market health, no reason to think a meaningful recession is on the way. By meaningful I mean negative growth, contraction within the economy; there may be a period in which growth slows from a faster rate to a slower rate, but I don't think that's going to happen over the next few quarters. The Atlanta Fed's GDPNow tool indicates an expectation for 4.1% growth in the 2nd quarter and leading indicators suggest continued expansion through the end of the year.


The 2nd quarter earnings cycle is about to ramp up to high gear, and things are looking good. Not only are we expecting earnings growth we are expecting robust double-digit earnings growth, for double-digit growth to continue for at least the next six earnings cycles and the estimates are on the rise. The only thing missing is that the growth rate is expected to top out in the next cycle, Q3, which could become a drag on the indices in the future.


All 11 S&P sectors are expected to show growth in the 2nd quarter. Five of those sectors have seen upward revision since the start of the quarter led by Energy. Based on past performance I do expect to see most if not all sectors beat their estimates this cycle. So far 19 companies have reported, and the signs are positive; 95% have beaten EPS estimates, and 89% have beaten revenue estimates. The blended rate of growth is 20% and expected to rise at least 4% by the end of the cycle, if not topping last quarters 24.8%.


Looking to future quarters the estimates are good and on the rise. The third quarter is now expected to post better than 21% followed by a near 18% increase in fourth. If estimates continue to rise both quarters could see growth above 20% with third quarter coming close to 25%. The key takeaway is that estimates are rising and that is a factor that can help lead the market higher.


The S&P 500 Technical Outlook

The S&P 500 was deep in correction at the start of the last earnings cycle and has not exited the pattern yet. The good news is that long-term trends remain intact and the weekly chart looks good. The index is sitting on the 150 day EMA and strong support; the EMA is on the rise, the indicators are weak but consistent with long-term uptrend and outlook is positive. Political turmoil could induce a move lower, but so far anytime that's happened a buying opportunity unfolded.


The daily chart looks the same. The index is still in correction, the market still in rotation, but above support levels and showing resilience. The indicators are mixed but rolling into a bullish trend-following signal that is confirmed by stochastic but not MACD. A move higher would be bullish, but the index still faces resistance at 2,800 and 2,880 before a new all-time high can be set. I expect to see earnings drive the market to retest the current all-time high, a move above that may be dependent on trade disputes.


Second Quarter Earnings Outlook; Sector By Sector

The Energy Sector (XLE)

The energy sector is still the biggest story in earnings growth. This quarter the sector is expected to see earnings grow at a rate near 150% and could easily top estimates. The growth is driven by rising prices for oil, prices that don't seem to have a top at this point, and likely to continue into the following quarters. The full year 2018 growth is expected to reach 100% and is up sharply from the 72% expected at the start of the quarter. My only concern is price outlook; the market is still well supplied despite recent disruptions and outlook supports that analysis. The EIA expects the average price in 2018 to be $64.50 and then fall to near $62.00 in 2019 which means a price correction in WTI is coming. The silver lining is that prices are expected to remain above $60 and at levels where the sector can make money.

My target for the XLE Energy Sector SPDR at last look was near $78, and that was reached a few weeks ago. Since then the ETF has corrected to support at $74 and is now trending sideways with resistance at the $76 level. The indicators are mixed but suggest a move higher is possible, considering earnings outlook I would say is likely. A break above $76 could take the index up to retest $78, a break above that level would be bullish and likely take the ETF up to the $83 level. I am bullish on the energy sector.


The Materials Sector (XLB)

The materials sector has been running a strong second place regarding earnings growth and is expected to retain that position in 2018. My take, economic expansion is everywhere you look so it is no wonder the sector is doing well; people need materials. The sector is expected to see earnings grow by 48.7% in the current cycle and that estimate is up from earlier this year. Looking forward full-year earnings growth is expected in the range of 28% for 2018 and then 7.5% in 2019, so there is a concern that growth is slowing.

At last glance, the XLB Materials Sector SPDR was expected to trend sideways within a range of $55.50 and $60 possibly $62, and that is what it did. The bottom of the range was closer to $60.25, and the top turned out to be $61 leaving the ETF trading near $58 right now. The indicators are mixed, consistent with range-bound trading, but suggest weakness within the range. A move lower may retest support targets at $57 or $56, but a deeper move is not expected with growth in the forecast. At worst I think the trading range will continue, at best we may see a retest of long-term highs. I am neutral leaning to cautiously bullish on this sector.


The Telecom Sector (XTL)

The Telecom sector is expected to post fairly robust earnings growth this cycle, but it's a peak that will lead to flat to low growth next year. The sector is looking at 27.3% growth this cycle (down in the last 30 days) and then decline to near 0% by the end of the year and for all of 2018. This puts the sector in last place relative to the other ten sectors, not the best place to look for bull market conditions.

The XTL Telecom SPDR was expected to remain range bound over the last three months, and it was, more or less. The ETF was able to move up and retest the pre-February correction highs, but the move was met by sellers. The ETF is now trading off that high but above support and indicated higher. This may lead to another retest of the $74.50 level I do not expect a move above it based on earnings growth outlook. I am neutral on the Telecom Sector.


Information Technology

The information technology sector has been one of the best performing over the past few years and is expected to continuing performing strongly over the next two. The sector is estimated to produce the fourth strongest growth in the second quarter and the fifth strongest for the year and next year. The only negative in the outlook is that growth will decelerate from an average 17.8% in 2018 to about 10% in 2019.

I was bullish on this sector the last update, and I am still bullish on it. The sector corrected along with the broad market and has outperformed in the time since. My target over the last quarter was a retest of the all-time high with a chance of breaking to a new all-time high above $71. Those targets have been reached bringing my longer-term targets of $75 and $80 into play. The trend is still up; the indicators are consistent with a bullish trend-following entry and price is moving above the short term 30 day EMA, so I remain bullish.


The Financial Sector (XLF)

The financial sector is no longer expected to post the second strongest earnings growth in 2018, but that doesn't matter. Growth for the second quarter is estimated to be 18.3% (estimates are rising) and then expand to 38.6% in the third for an average 27.2% in 2018 (this puts it in 3rd place). The takeaway here is that, while growth in other sectors has already peaked it will not peak in this sector until the next quarter, or the quarter after. The downside is that growth will moderate to only 10.5% in 2019.

I was bullish on this sector last quarter, and that turned out to be the wrong call. The XLF Financial Sector SPDR bobbed along at my support target for two months until falling through it a few weeks ago. The moving averages have produced a bearish crossover which suggests a downtrend has started but, with earnings outlook as strong as it is I just don't see a bear market developing. Support is now near $26.50, a break below which could take the ETF down to $26 or $25. The indicators are both consistent with a bullish swing in prices, a move up would confirm the indication, but resistance is present at the moving averages. A break above there would be bullish. I am cautiously bullish on this sector.


Consumer Discretionary (XLY)

The Consumer Discretionary sector has been my top pick regarding earnings growth and outlook for several quarters, and it is still high on my list. The sector is expected to post a growth of 14.3% in Q2, up from the first quarter, and expand into the end of the year. The sector is expected to post earnings growth of 18.0% in the third quarter and average 17.5% for the year. The only negative is that, like most other sectors, growth is expected to moderate in 2019. The mitigating factor is that growth is expected to approach 13% in 2019, the strongest growth of any sector after the energy sector.

I was bullish on the Consumer Discretionary SPDR XLY last quarter and remain so today. At last look, I was expecting a move above the short-term moving average, near $103, and a continuation of long-term trends. My target was $110.00, and that has been exceeded. The ETF is now consolidating at the short-term moving average again and poised to move higher along with earnings. My near-term target is the all-time high near $112.50, a move above that would be bullish and take the sector up to new all-time highs with targets near $1150 and $120.


The Industrial Sector (XLI)

The Industrial sector is expected to show earnings growth near 12.5% for the second quarter, and that estimate has moderated slightly in the last 30 days. Looking forward the sector is expected to see earnings growth expand to 18% in the 3rd quarter and average above 17.5% for the year. Looking to next year growth is expected to moderate along with the broad market but will still come in above 12.% and well above the index consensus average.

At last look I was cautiously bullish on the XLI Industrial Sector SPDR due to divergences in the indicators, the cautious part at least was right. The index made a small move higher and then proceeded to trend sideways within a large range until now. The ETF is now consolidating near the low end of that range and appears set to rebound. The indicators are mixed but consistent with a bullish swing in prices that could take the ETF up to $74 and $76 in the near to short term. A move above $76 may be bullish until then I am cautiously bullish.


The Healthcare Sector (XLV)

The Healthcare Sector is expected to post solid, steady earnings growth over the next six quarters. Based on demographic trends it is also expected to see steady expansion over the next two decades as the US population grows and ages. The sector is expected to see growth near 10% this quarter, next quarter and next year making it the most consistent earnings grower of all 11 sectors.

I was bullish on health care last quarter, and I am still bullish on it this quarter. My target for the XLV Healthcare SPDR was $86, and that has been reached. The ETF is now moving up from the short and long-term EMA's and setting a new four month highs. The move is in line with the long-term trend and supported by the indicators which are both firing bullish entry signals. My target for this ETF is now a retest of the all-time high with a possible pause/consolidation at the $87 level.


Consumer Staples - XLP

The consumer staples sector is expected to see fairly steady growth over the next six quarters. The second quarter is expected to produce 8.0% earnings growth at least, with that expanding to 9.8% in the third and near 11% in the fourth. Average growth is expected to be 10.2% this year and then fall to 7.0% next year. While earnings growth is tepid compared to the broader market, 7% is still good and supported by two things that could spur upside surprises; improving labor markets and an expanding population. While not a huge growth opportunity this is another safe sector with above average yield investors turn to in uncertain times, another reason to like it now.

I was neutral on the Consumer Staples SDPR XLP and looking for a possible retest of support at the $51 level. The support level was tested and exceeded resulting in a move to $49 and 2.5 year low. This low has since resulted in a move higher leaving the ETF testing resistance at $52 and the short term moving average. The near-term trend is down, driven by rotation to cyclical sectors, and the chart is set up for a sell signal, so a move lower is possible. A move above the short-term moving average may be bullish; a move lower could be bearish. I am neutral on this sector for shorter term trades but would consider bullish positions on longer-term dividend payers.


The Real Estate Sector (XLRE)

The real estate sector is expected to produced earnings growth over the next two years, but it is not going to be a market leader. The sector is expected to see growth near 5.7% this quarter, 6.4% next quarter, 6.1% this year and 6.2% next year. The steady pace of growth is nice and will help drive dividends. The XLRE Real Estate SPDR yields about 3.3% at current levels, near $33.5, a factor that will lend support over the long term.

The XLRE Real Estate SPDR bobbed along support for a month or so following my last look and has since moved up to test and exceed my resistance targets. The ETF is now moving up toward its all-time high and is supported by the indicators. The sector, due to its dividend, has been a haven during the market consolidation and may continue to be so until the trade war blows over. I am bullish on the sector with a target of $34, a break above that level would create new targets at $35 and $36.


The Utilities Sector (XLU)

The utilities sector is expected to maintain earnings growth over the next six quarters, but the outlook is not rosy. The sector is expected to post growth of 2.1% this quarter (the weakest sector of the 11) and 9.6% next quarter (second weakest) with the full year at a mere 10.1% (well below average). Next year growth is also expected to be weak at 6% and the slowest rate except for the telecoms. What it has going for it right now are dividends (the XLY pays 3.3% compared to 1.80% with the SPY) and non-cyclical safe-haven appeal.

I was bearish on the XLU Utilities SPDR last quarter, and that was the wrong call. Steady earnings, higher than average dividends, steady growth and non-cyclical safety came back in vogue along with escalating trade tensions. Regarding earnings, the sector is expecting growth over the next six quarters but not strong growth. My target for firm support was near $48 provided earnings and outlook did not disappoint the market and that level held. The ETF is now moving higher and setting new seven month highs supported by the indicators. The indicators are both bullish and suggest further upside is possible. My targets are $54 and $56. I am bullish on this sector.


My Conclusion

I am bullish, cautiously bullish or neutral leaning toward bullish on every sector except the telecoms and in that case, I'm just neutral, not bearish. In the case of the cyclical sectors, there is a risk in that escalating trade tensions could and will take their toll on global economics and earnings. In the case of the non-cyclicals there is a risk that trade tensions will evaporate and the market will return to its cyclical focus. In either case the market is more likely to enter (continue, I should say) a trading range than not. If things go on as they are, with a little bit of fear and a little bit of hope, it looks like we're set up for a broad market rally, a rally supported by earnings growth, outlook, and dividends. I am still firmly bullish for the long term, cautiously bullish for the near term, and optimistic earnings season will not disappoint.

Until then, remember the trend.

Thomas Hughes