Earnings To Test Cyclicals
The change in stock-market leadership since midyear has been striking — and mostly encouraging. The bond-like stocks that did best in the first half of the year — utilities, telecoms, and consumer staples — have slumped since June 30. The financials and technology sectors, both first-half laggards, have been leaders since June 30. Industrials and energy, helped by higher oil prices, have also outperformed since midyear.
Typically, investors like to see groups tied to the economy performing well, as these stocks tend to do best when expectations for corporate earnings are improving. When defensive groups like utilities and consumer staples lead, it can signal that investors expect the earnings environment to worsen.
Continued strength in cyclical stocks during earnings-reporting season would be encouraging, but recent downbeat guidance from Alcoa ($27; AA), Dover ($67; DOV), Honeywell ($107; HON), and PPG Industries ($92; PPG) has heightened worries regarding the industrials sector.
Among the 11 sectors of the S&P 500 Index, industrials are expected to report the second-largest profit decline (down 8%) for the third quarter, according to FactSet. Only the energy sector (down 69%) is expected to report a sharper year-to-year decrease.
Earnings for the entire S&P 500 Index are expected to be down 2.1%, or up 1.3% excluding energy, according to FactSet. Assuming results beat expectations by the average amount seen over the past four years, overall earnings should end the third quarter up nearly 1%, which would mark the first increase since the first quarter of 2015.
The number of companies that have warned on September-quarter earnings is lower than recent norms, as is the percentage decline in the consensus estimate for the S&P 500 since the quarter began. While those trends provide grounds for optimism, investors care more about the outlook for the fourth quarter and beyond.
As always, the stock market's reaction will provide the best gauge of whether results and guidance have met expectations. Fresh all-time highs in the Dow Industrials and S&P 500 Index, which would require rallies of less than 3%, would bode well for the broad market.
With the recent move to significant highs in the Dow Transports, we view the primary trend as bullish under the Dow Theory. Still, we'd like to see the Dow Industrials and S&P 500 Index break to new highs during earnings season. Our Buy List and Focus List have 87.6% in stocks, while our Long-Term Buy List has 83.6%.