Despite a Recession, These Sectors Are Still Hitting the Mark

Investors are setting their sights on a strong close to the year...

We're basically through third-quarter earnings season. Most companies have released quarterly results. And we have a clear picture of their performance.

This is a good opportunity to check on how corporations are doing. For most companies, the fourth quarter ends on December 31. So we can get a sense of what to expect from full-year earnings results.

It looks like we're in the midst of what's called an "earnings recession." That happens when trailing 12-month ("TTM") earnings decline for two or more consecutive quarters.

TTM earnings fell in the second quarter compared to the first. And with 97% of companies reporting third-quarter earnings, it looks like they've dropped again.

As-reported TTM earnings for the S&P 500 have weakened from $198 billion in the first quarter to $192 billion in the second quarter... and down to $187 billion in the third quarter.

Even so, the most worrying thing isn't that earnings are down. We've known this would be the case for almost half a year.

What's truly worrying is that earnings trends are deteriorating...

Over the past 10 years, an average of 72% of companies beat earnings estimates. This number improved since the pandemic began. Since the second quarter of 2020, the beat rate jumped to a staggering 81%.

That's no longer the case. Only 69% of companies beat earnings estimates in the most recent reporting cycle. It's a worrying sign for the market as a whole... And it furthers our concern that we're likely to get a "real" recession in 2023.

Still, that doesn't mean everything is bad. The market doesn't move in unison. Individual sectors can enjoy huge tailwinds or fight massive headwinds. These can pull the overall market in one direction or another.

And where one sector struggles, another might find success.

This can be easy to ignore when the overall market is improving. That's not the case today. We're facing a downturn... So it's important to look deeper at individual sector trends.

We can see this by examining quarterly earnings beats and misses on a sector level.

It's not enough to just look at a sector's surface-level performance to see if earnings went up or down.

You also need to consider whether earnings are getting weaker or stronger than analysts expect. At the end of the day, outperforming expectations helps propel a company's stock price.

Five sectors performed above average in the third quarter...

The top area was consumer staples, followed by energy... which has some sound tailwinds. Energy has been able to deal with inflation, and strong demand should benefit the sector in the near term.

(It's worth noting that if inflation continues to rise and we enter a real recession, people will tighten their purse strings even more. Consumer staples companies will find it hard to raise prices. So the same tailwinds that are helping energy could actually hurt consumer staples going forward.)

On the opposite end of the spectrum, there were some notable underperformers. Communication services – a market darling for the past 10 years – was the worst-performing sector of the third quarter.

Take a look...

Less than half of companies in this sector beat estimates. Companies like Google parent Alphabet (GOOGL) and Facebook owner Meta Platforms (META) have been feeling the pressure of a contracting economy.

Real estate has also been crushed thanks to rising interest rates. Its beat rate was marginally better than communication services, at 48%.

The data shows us that consumer staples and energy are trending upward. That gives us a great starting point to identify promising stocks. (Remember, 50% of stock performance is based on the underlying sector.)

From there, we have to consider how the sectors are set to perform in the current environment. That's why we like energy better than consumer staples today.

The same data also tells us what areas of the market to avoid. Communication services and real estate have disappointed investors lately. It's a good idea to stay away from these sectors until the trend reverses.

Regards,

Joel Litman
December 12, 2022

Editor's note: We're likely in the midst of an earnings recession... and on the verge of a "real" downturn. While everyone else is worried about inflation, cryptocurrencies, and a possible crash, Joel says it really doesn't matter if stocks plunge.

What matters is that you position yourself in the right parts of the market...

Joel recently released a brand-new presentation naming the three sectors his systems expect to fall in 2023 – and the three that are best-positioned to soar. Plus, he revealed the names and ticker symbols of the top stocks to own as the story plays out. Learn how to get access right here.