Four key sectors to watch closely this earnings season

The second-quarter earnings season kicked off in earnest on Friday with the first reports from big banks, and investors should now brace for what will be a key test of sentiment.

The stock market is at lofty levels after repeatedly setting records this year, and companies need to show earnings growth to justify the move. Even the Federal Reserve has pointed out that stock valuations are above historical norms.

The FactSet blended year-over-year per-share earnings growth rate estimate for the S&P 500, which combines results for those companies that have reported (companies with a fiscal quarter that ended in May) with those still to come, stood at 6.3% on Wednesday. That’s below the 13.8% rate recorded for the first quarter, which enjoyed the easiest comparison of any period this year.

That’s because the first quarter of 2016 marked the trough of the earnings recession, the long stretch of earnings declines that started in the third quarter of 2015. Analysts expect the second-quarter rate to improve as the earnings season gains pace and revisions move up. But the question for investors, is whether earnings valuations will improve enough to support the S&P 500 index’s S&P500  rapid rise this year toward record levels.

“We believe another quarter of double-digit earnings growth for the S&P 500 in the second quarter is possible, given generally solid overall economic data, the strong rebound in energy sector profits, and solid financial and technology sector earnings gains,” said Burt White, chief investment officer for LPL Financial. “Earnings estimates have been resilient and the ratio of positive to negative pre-announcements is as positive as it has been in three years.”

The energy sector is expected to lead second-quarter gains, mostly because it is recovering from a very low base. In the more than two years that oil futures prices have drifted lower and lower, companies have slashed capex budgets, sold assets and made other moves to get back to growth in a low oil-price environment.

The tech sector is expected to be second-strongest, driven by chip makers, which are enjoying strong demand -- and stock price gains -- thanks to the self-driving trend, the popularity of videogaming and 0

Energy will rebound, but outlook is unclear

The energy sector is expected to post earnings growth of 387% for the quarter, and sales growth of 17%, according to FactSet, as it rebounds from the crushing losses of the past two years. But results will be uneven across the various segments of the market with the major integrated oil companies and refiners expected to enjoy the biggest gains and results from oilfield services companies expected to be more subdued.

The outlook for the rest of the year is less certain, as oil futures prices have not performed as expected so far. 2017 was supposed to be another year of recovery, and it started with most experts cautiously optimistic about global oil markets on hopes that an improving global economy, more demand and a slowdown in production growth would result in higher prices and diminishing stockpiles.

Analysts at Barclays downgraded their view on oilfield services companies this week to neutral.

The FAANG factor

Tech has been the most important driver for Wall Street since the end of the Great Recession, but its dominance is in question after a sudden downturn in technology stocks last month. This quarter’s earnings reports appear ready to determine if these stocks deserve their high prices, which could create the most important earnings season for Silicon Valley since the dot-com bust.

Projections show expectations for year-over-year earnings gains of more than 10%, and sales gains of 12% in the information technology sector.

Those large tech companies may determine the eventual outcome of tech’s earnings season due to their large weights in indexes.

The reports scheduled for the next few weeks will be important in determining the future for the sector.

Banking and financials

The financial sector is expected to show earnings-per-share growth of 5.5% over a year ago, according to FactSet, which currently puts it in third place among the 11 S&P 500 sectors, behind energy and information technology. But the EPS growth estimate fell sharply during the quarter, from a consensus of 8.6% growth as of March 31.

Investors should keep in mind that the year-over-year growth in EPS can be somewhat misleading. Banks have been aggressively buying back their own shares, because of “limited opportunities to allocate capital to value generating investments,” analyst Saul Martinez at UBS wrote in a recent note to clients.. “In fact, a substantial portion of EPS growth is currently driven by share buybacks, not earnings growth.”

The retail wreck

The SPDR S&P Retail exchange-traded fund XRT, +0.95%  has fallen 9.0% over the past year, while the S&P 500 has climbed 13.7%.

“Three things characterize the current transformation,” Deborah Weinswig, managing director at Fung Global Retail and Technology, wrote in the group’s latest report. “Traditional retailers such as department stores and specialty retailers are undergoing huge disruption, emerging players in different segments are intensifying competition and higher e-commerce penetration is challenging brick-and-mortar retailers.”

Source: Bloomberg Pro Terminal

Junior Trader Stefan Panteleev

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