Solid second-quarter earnings provided a fillip to the U.S. equity market despite political turmoil both at home and abroad. A similar shot in the arm is expected in the third quarter, with American corporations showing signs of strength on the back of an improving economy.
Both manufacturing and service sectors accelerated at a record pace in September, while the U.S. economy is growing close to the range expected by President Trump and some other Republicans. A clearer view of last month’s labor market data shows that keeping the effects of the hurricane aside, U.S. employment scenario is continuing to tighten.
The third-quarter earnings season, unofficially, begins mid-October. It is seen as the biggest catalyst for the broader markets that could help major indices continue their winning streak. Thus, for the next few weeks, let us keep an eye on stocks that are likely to make the most of the third-quarter earnings season. Here, we should also bear in mind that better-than-expected earnings performances generally lead to a rally in the share price, which eventually enthralls almost everyone, right from the top brass to research analysts (read more: 5 Top Large-Cap Earnings Growth Stocks to Buy Now).
Q3 Earnings Outlook
Earnings have been pretty strong so far this year. Earnings growth in both the first and second quarter for the S&P 500 companies was in double-digits. Morgan Stanley (MS - Free Report) expects such companies to top forecasts in the third quarter as well, which will take the S&P 500 closer to the 2,575 mark by the end of October. The benchmark index is currently trading at around the 2,544 mark. Morgan Stanley’s forecast would mean additional gains of 1.2% by the end of the month. Further, the banking giant expects the broader gauge to end the year at around 2,700.
Total third-quarter earnings are expected to be up 2.2% from the same period last year on 5% higher revenues. Expectations of earnings may not be excessively high, but, still looks solid as economic indicators shows positive signs.
Strong Economic Backdrop
A key yardstick of manufacturing activity in the United States scaled a 13-year high in September, while non-manufacturing activity rallied to a 12-year high. According to the Institute of Supply Management (ISM), the manufacturing index climbed to 60.8% in September from 58.8% in August. The non-manufacturing gauge was at 59.8% last month, as compared with 55.3% in the prior month (read more: U.S. Manufacturing Activity Hits 13-Year High: Top 5 Winners).
Additionally, U.S. GDP expanded 3.1% in the second quarter, the fastest in more than two years. It is also up slightly from a previously reported 3%. An uptick in consumer outlays and business investments drove the upside.
September jobs report, in the meanwhile, showed the first monthly decline in payrolls in seven years. Investors, however, mostly ignored the surprise contraction which was led by unprecedented events such as hurricanes Harvey and Irma. Let’s not forget that even during such trying times, the unemployment rate remained at a 16-year low and wages increased 0.5% to an average of $26.55 an hour, per the Labor Department data. In fact, in the last 12 months, hourly pay increased 2.9%, up from 2.7% in the prior month and also in line with a post-recession high.
Potential Gainers & Losers of Q3
The energy sector, in particular, is expected to record the strongest growth in the third quarter. Total earnings for the sector are expected to grow a whopping 121.9% on 17.2% higher revenues. The energy sector is benefitting from an uptick in oil prices, which is gaining strength as demand is strong in Europe and the United States. Needless to say, the oil market has been suffering owing to oversupply concerns for quite some time now.
As per the International Energy Agency (IEA), global oil demand grew by 2.3 million barrels per day (bpd) in the second quarter on a year-over-year basis. The IEA also revised the growth estimate for this year upward to 1.6 million bpd.
Earnings for the technology sector are set to grow 9.7% from the same period last year. Substantial growth in cloud computing and the Internet of Things, artificial intelligence, gaming and the launches of increasingly complex smartphones and consumer electronics are cited to be some of the reasons that have boosted the sector in recent times.
Improved chances of some form of tax reform making it through the house also benefitted the technology sector. Tech behemoths like Apple (AAPL - Free Report) , Microsoft (MSFT - Free Report) , Alphabet (GOOGL - Free Report) , Cisco Systems, Inc. (CSCO - Free Report) and Oracle (ORCL - Free Report) hold 88% of their money overseas. The tax plan seeks to encourage such multinationals to bring those profits back to the United States by cutting the tax rate.
Industrials sector, in the meanwhile, is expected to rise in mid-single digits. High profits are also expected from conglomerates and construction segments as well. But, bank earnings are expected to disappoint mostly due to persistent deceleration in loan growth and soft trading revenues. Total third-quarter earnings for the Zacks Major Banks industry is expected to be down 5.1% from the same period last year on 2.2% higher revenues (read more: Are Bank Stock Gains Sustainable?).
The table below shows what is expected from the different sectors in Q3, compared with what was achieved in the preceding quarter.
(Source: Zacks Investment Research Inc.)
(Date as of: October 6, 2017)
Buy These 5 Stocks for Stellar Earnings Growth
A very strong economic backdrop looks set to deliver another round of positive earnings growth in the third quarter. This calls for investing in five companies from the aforesaid sectors, which are expected to report a significant uptick in third-quarter earnings.
These stocks have a positive Earnings ESP. This is our proprietary methodology for determining stocks that have the best chance to surprise with their next earnings announcement. It provides the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate. You can uncover the best stocks to buy or sell before they are reported with our Earnings ESP Filter.
These stocks, in the meanwhile, also flaunt a Zacks Rank #1 (Strong Buy) or 2 (Buy) and a VGM Score of B. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three metrics. Such a score allows you to eliminate the negative aspects of stocks and select winners.
Covanta Holding Corp (CVA - Free Report) , through its subsidiaries, owns and operates infrastructure for the conversion of waste to energy, as well as other waste disposal and renewable energy production businesses. Covanta Holding, which is part of the Zacks Alternative Energy - Other industry, has a Zacks Rank #2. The company is expected to report earnings results for the quarter ending September on Oct 24. Covanta has an Earnings ESP of +40.54%.
KEMET Corporation (KEM - Free Report) is a manufacturer of passive electronic components. The company, which is part of the Zacks Electronics - Miscellaneous Components industry, has a Zacks Rank #1. The company is expected to report earnings for the quarter ending September on Nov 7. KEMET has an Earnings ESP of +7.46%.
HubSpot Inc (HUBS - Free Report) provides a cloud-based marketing and sales software platform. The company, which is part of the Zacks Internet - Software industry, has a Zacks Rank #2. The company is expected to report earnings results for the quarter ending September on Nov 1. HubSpot has an Earnings ESP of +32.84%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Facebook Inc (FB - Free Report) is focused on building products that enable people to connect and share through mobile devices, personal computers and other surfaces. The company, which is part of the Zacks Internet - Services industry, has a Zacks Rank #1. It is expected to report earnings results for the quarter ending September on Nov 1. The company has an Earnings ESP of +1.76%.
Alcoa Corp (AA - Free Report) is engaged in the production of bauxite, alumina and aluminum of various cast and rolled products. The company, which is part of the Zacks Metal Products - Distribution industry, has a Zacks Rank #1. The company is expected to report earnings for the quarter ending September on Oct 18. It has an Earnings ESP of +6.8%.
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