With Q3 earnings growth expected to shrink, investors need to brace themselves for the possibility of a bear market over the next several months.
Analysts have grown increasingly pessimistic about Standard & Poor's 500 aggregate earnings in the last two quarters of 2015. June's estimates for a Q3 decline of 1% year over year have worsened to estimates of a 5.5% drop. For Q4, the estimates have swooned from a 4.3% increase to a 0.4% decline.
And that comes on top of the 0.7% decline in Q2 earnings. Two or more consecutive quarterly declines in year-over-year earnings qualifies as an "earnings recession." Such events usually coincide with bear markets. The last earnings recession occurred in 2009.
The good news is that the forecast for 2016 is for a sharp rebound in earnings growth. But stocks still need to muddle through two quarters worth of less than stellar earnings.
An earnings recession is one more negative among a sea of negatives for the stock market - and why a short-term bear market is looking increasingly likely. The S&P 500 is already down 3.23% on the year.
It means a steady drumbeat of disappointing numbers for the next six months.
Why This Adds Up to a Bear Market
"The single most determinant variable is going to be earnings at this point," Mark Freeman, chief investment officer at Dallas-based Westwood Holdings Group, told Reuters.
A decline in a company's earnings increases its price/earnings ratio, making the stock, from an investor's perspective, more expensive.
An earnings recession will only amplify the anxiety in the markets from a range of other issues, namely:
- Concerns about a slowing Chinese economy
- Concerns about economic weakness in the Eurozone
- The decline of emerging markets as an engine of growth
- Uncertainty about when the U.S. Federal Reserve will start raising interest rates
- Concerns that a possible U.S. government shutdown in December will nick the U.S. economy
"There are some wicked winds swirling around from a macro perspective and you can't afford to be complacent," Alan Gayle, head of asset allocation at Atlanta-based RidgeWorth Investments, told Reuters.
The threat of a bear market, even a short-lived one, means investors need to exercise caution in the weeks ahead.
But the nature of this earnings recession will also present investors with these opportunities...
Bear Market or Not, Here's Where to Look for Profits
Fortunately, the forecasters don't just predict what they think will happen with the S&P 500 earnings as a whole - they also make predictions by sector. That gives investors an idea of which sectors to target and which to avoid.
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According to FactSet, four sectors are expected to report growth, while six sectors are expected to fall in Q3.
The energy sector is expected to have a horrific quarter, with a 64.3% drop in earnings year over year.
The other "losers" include materials (a projected 18.5% decline), industrials (-5.7%), and consumer staples (-2.4%).
The sectors that will buck the earnings recession trend in Q3 - and any bear market that might ensue - includes telecom (expected to rise 18.4%), consumer discretionary (9.9%), healthcare (6.3%), and financials (4.3%).
The outlook for Q4 is similar. Energy is expected to suffer a 61.8% drop year over year, materials a 12.4% fall, and information technology a 2.5% decline.
The Q4 winners include telecom (25.7%), financials (16.4%), consumer discretionary (10.6%), and healthcare (6.4%).
FactSet also provides earnings projections for the 2016 calendar year. The three sectors expected to outperform the overall market next year are consumer discretionary (15.6%), materials (14.5%), and healthcare (11.6%).
Meanwhile, Capital IQ data says investors should also look past the large companies to find better returns. Mid-cap companies will see a 40% gain in profits in Q3, and small caps an 18% gain.
Follow me on Twitter @DavidGZeiler.
Another Way to Profit from Q3 Earnings: In addition to focusing on the best-performing sectors, investors have other tools to make gains from earnings this quarter. In particular, investors can use options to take advantage of patterns in individual earnings reports. And Money Morning Options Expert Tom Gentile knows just how to do that...
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About the Author
David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.
Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.
Dave has a BA in English and Mass Communications from Loyola University Maryland.