Beginning this week and continuing over the next month or so, results from thousands of American companies will be reported as we move through third-quarter reporting season.
While there’s always plenty of anxiety and a lot riding on earnings season, there’s much more at stake this time around because S&P 500 companies are facing the first earnings recession since this bull market began in 2009.
And if the trend in S&P sales and profits doesn’t improve soon, we could soon be facing a new bear market for stocks.
Earnings-per-share results for S&P 500 companies are on pace to decline 5.5% year-over-year for the third quarter. That would mark the second straight quarterly drop in profits, for the first time since early 2009!
Even more troubling, top-line sales for S&P 500 stocks are on track to decline for the third-straight quarter, with a 3.3% decline forecast by analysts.
What’s more Wall Street is expecting another sales and earnings decline during the fourth quarter of 2015 as well.
Considering the market volatility investors have experienced since July, plus weakening data reports on the U.S. economy, the LAST thing investors need to worry about right now is an oncoming earnings recession.
Profit margins peaked at 10.5% for S&P 500 companies earlier this year and investors are beginning to ask: Was this as good as it gets for this business cycle? It becomes a critical question because of the glaring lack of top-line sales growth for the past nine months in a row.
Profit margins expanded in recent years based mainly on a combination of:
1. Cost-cutting …
2. A lack of investment in capital equipment, and …
3. Record share buybacks by public companies
But without organic sales growth, sooner or later, something’s got to give on the bottom line. Even if sales stayed flat, there are not a lot of excess costs left to cut in order to boost earnings growth.
In an environment like this, it’s critically important to pay attention to which stocks and sectors are still capable of growing their top and bottom lines, and which can’t.
It will be much more of a stock-pickers market now, with investors willing to pay a premium for the few companies that are able to maintain growth.
With that in mind, let’s take a closer look at the sectors that are expected to contribute the most and the least to third-quarter results.
The ugly: The worst offenders this quarter are likely to be energy and basic materials stocks, which has been a familiar theme. Plunging oil and gas prices along with the freefall in many other commodities is likely to keep these companies reporting dismal results this quarter and beyond.
In fact, energy stocks in the S&P 500 are expected to post a 64.3% earnings decline this quarter, while basic materials profits are forecast to drop 18.5%!
The bad: Earnings growth for S&P 500 industrial sector stocks has been decelerating for the past two quarters, and profits are set to decline 5.7% in the third quarter.
This is troubling sign that weakness in energy and materials is spilling over to other cyclical sectors of our economy.
The good: On a positive note, health-care stocks are set to report sales up 8.1% from a year ago with earnings per share advancing 6.3%. Another good sector, financials are expected to post profit growth of 4.3% while revenues jump 4.9% for the quarter.
Perhaps not coincidentally, our own Weiss Stock Ratings model also favors financial stocks right now. The majority of financial stocks we cover (62.2%) earn a buy rating at present, or 383 buy-rated stocks in all.
Bottom line: Keep a sharp eye on corporate sales and profit results over the next several weeks, because it could be a key catalyst to determine the direction for stocks. If results generally come in better than expected, select buy-rated financial stocks might be a good place to look for new buy candidates.