Investors haven't been particularly pleased with the Q1 earnings season. They seem to be surprised that the earnings picture is so weak. I am not that surprised. In fact, as regular readers know, I have been constantly railing against the disconnect between a stock market at all-time highs and a fairly weak earnings picture.

The earnings question isn't so much about Q1 results, but rather what these results tell us about the coming quarters. The Q1 earnings season itself hasn't been that bad, particularly when compared to the last few quarters. The aggregate numbers for the 112 S&P 500 companies that have reported results already in terms of growth rates, surprises, and guidance aren't materially weaker from the same group of companies in the 2012 Q4 and Q3 earnings seasons.

But this earnings season has arrived in a backdrop of renewed concerns about the economy, both here in the U.S. and in China, as well as other markets. The recent turmoil in the commodity markets is essentially a reflection of this uncertain economic growth outlook. The market seems to be connecting the dots of a weakening economy and still optimistic earnings expectations for the coming quarters, particularly the second half of 2013 and full year 2014.

Consensus expectations for the first half of 2013 appear quite reasonable, with total earnings expected to increase by only +1.4% from the same period in 2012. But estimates for the back half of the year represent a significant increase of +10.8% over the 2012 period. Consensus estimates then extrapolate the expected second-half 2013 growth recovery into 2014, resulting in further gains of +11.6%. It is hard to envision these growth expectations panning out in the current backdrop of slowing economic growth at home and abroad.

Spotlight on the Tech Sector

My focus in today's write-up is on the largest sector in the S&P 500 - the Technology sector. While aggregate Q1 results thus far for the S&P 500 are comparable to what we have been seeing in the last few quarters, results from the Technology sector are on the weak side. The goal is to use an analysis of expectations for the coming quarters as a means to appreciate the sector's, and the broader S&P 500's, earnings outlook.

Apple's earnings report won't be out until after the close on Tuesday, but we have seen enough reports to start judging the sector's performance. As of Monday evening (4/22/13), we have Q1 results from 15 of the 69 Tech sector companies in the S&P 500. This is barely 1/5th of all Tech companies in the index, but keep in mind that these 15 companies include many of the industry heavyweights, like Google, Microsoft, Intel, Oracle, Texas Instruments and others. These 15 companies combined account for 47.8% of total Tech sector market capitalization and account for 43.8% of all Q1 earnings expected from the sector.

Total earnings for these companies are up +3.9% from the same period last year, with 66.7% of companies beating earnings estimates. Total revenues are up +4.8%, but only 33.5% of the companies have come out with positive revenue surprises. The growth rates look decent enough, but they will disappear following Apple's report, which is expected to show a -16.8% year over year decline. The composite earnings growth rate for the sector, where we combine the results that have come out with those still to come, is for a decline of -5.9% from the same period last year. Excluding Apple, Tech earnings would be down only -2.3%.

But irrespective of the growth rates, the 'beat ratios' (the percentage of companies coming ahead of expectations) are weak, and are notably so on the revenue side. The earnings 'beat ratio' of 66.7% is weaker than the aggregate for the S&P 500 as a whole and relative to how these same group of companies performed in 2012 Q4, but the revenue 'beat ratio' of 33.5% is outright mediocre.

So, what's going on with Tech earnings?

The Key Trends

Investors have soured on Apple big time and hardly anyone is expecting fireworks from the company in tomorrow's release, particularly following last week's negative pre-announcement from Cirrus Logic. But Apple still matters – to the sector as well as the market. After all, even if it's results came in-line with expectations (a decline of -16.8%) tomorrow, its earnings will account for more than 22% of the entire sector's Q1 earnings.

In many ways, Apple's problems are very company-specific: a function of competitors finally catching up to it. Apple's smartphones and tablets no longer have the field to themselves. What this means is that Apple's growth outlook is a lot less certain than was previously believed. Earnings estimates for Apple have been coming down persistently, and the trend may not have fully played out yet.

Apple's problems may be company specific, but plenty of its Technology peers are faced with similar earnings challenges. In Intel's earnings report last week, we saw how the weak PC demand picture is weighing on its outlook. The situation isn't much different for other PC centric players like Hewlett-Packard, Dell, Microsoft and Advanced Micro Devices, to name just a few. Ironically, Apple played a leading role in bringing the PC market to its knees.

Others are faced with different headwinds that lead to the same earnings challenges. Companies with advertising-based business models like Google, Facebook, Yahoo and others are struggling with monetizing the secular shift from PC to mobile devices. This platform shift has material consequences for these companies' margins, as do the headwinds facing Apple and the PC players.

Expectations Beyond Q1

A key driver of the Q1 earnings weakness for the sector is from margin pressures. Net margins in the quarter are expected to be down 177 basis points from the same period last year, which more than offsets the stronger-looking +3.3% gain in revenues, resulting in -5.9% decline in total earnings.

The first and third quarters are typically the seasonally weakest periods for the sector. As such, the market may be willing to cut the Tech companies some slack for a weak showing this reporting season. But a lot will depend on how they guide towards the coming quarters, as expectations, particularly in the second half of the year, are for a resumption of strong growth.

Current consensus expectations are for total Tech sector earnings to increase by +8.3% in the second half of the year after declining by -5.2% in the first half. The second half recovery is then expected to carry into 2014, resulting in total earnings growth for the sector of +13.2%. A big part of these earnings recovery hopes rest on margin expansion.

On a quarterly basis, net margins for the sector peaked in 2012 Q3 and have yet to get back to those levels. On an annual basis, the sector's net margins have been essentially flat since 2011, but are expected to make strong gains later this year and next year after contracting in the first half of 2013. Hard to envision such margin gains given the multiple headwinds facing them.

Putting It All Together

What all this boils down to is that earnings expectations for the broader S&P 500 in general and the dominant Technology sector in particularly remain elevated. I am not talking about estimates for the currently underway first quarter of 2013, but the coming quarters, particularly the second half of the year and next year. Those estimates need to come down and they most likely will come down after we hear from management teams.

Tech stocks haven't been the leading stock market performers this year, up +4.8% year to date vs. the +10.1% gain for the S&P 500. It is perhaps reasonable to expect this group to give back some of those modest gains in the coming days.

Focus List Update

We made 12 changes to the Focus List this week – adding and deleting 6 stocks each. Four of the six deletions were to comply with our operating guidelines that require us to exit stocks that have fallen to a Zacks Rank #4 (Sell) or Zacks Rank #5 (Strong Sell). A Zacks Rank downgrade provides an excellent signal of deterioration in near-term earnings momentum, which always has a bearing on the stock price.

Our deletion of Monster Worldwide ( MWW - Analyst Report ) , Apogee ( APOG - Analyst Report ) , Sketchers ( SKX - Analyst Report ) and DTE Energy ( DTE - Analyst Report ) were to reflect such Zacks Rank downgrades. Monster turned out to be a losing position for us, while Apogee barely broke even. But we pocketed nice gains in Sketchers (up +15.7%) and DTE Energy (up +24.1%).

We had even more impressive gains in the two refining stocks that we deleted from the Focus List - Tesoro ( TSO - Analyst Report ) and Western Refining ( WNR - Analyst Report ) . We had +110.3% gain in TSO since March 2011 and the WNR position was up +32.2% since its addition to the portfolio in July 2012. But estimates have been slipping lately and I wanted to cash out our gains. I like refiners and wouldn't mind getting back into Tesoro at a future stage.

The six additions meet different needs of the portfolio, but they all have a Zacks Rank #2 (Buy). Avery Dennison ( AVY - Analyst Report ) and Traveler's ( TRV - Analyst Report ) are large-cap industry leaders with attractive dividends that should help anchor the portfolio in times of heightened volatility. Hanesbrands ( HBI - Analyst Report ) is an apparel maker with an excellent earnings profile and attractive long-term growth prospects that recently initiated a quarterly dividend (yields about 1.7%).

Hewlett-Packard ( HPQ - Analyst Report ) may be a little controversial, but the PC industry's problems are well known and this company is due for a turnaround, which the company's no-longer-so-new CEO is expected to execute. The Regions Financial ( RF - Analyst Report ) addition is part of our plan to add exposure to regional banks and the Canadian Pacific ( CP - Analyst Report ) pick is essentially a play on this railroad's dominant position in transporting crude oil from Canada to the U.S. Even if the U.S. government eventually gives the Keystone pipeline the green light, rail transportation of crude oil will remain a significant growth driver for CP for a number of years to come.