Which Sectors to Focus on as Q4 ’16 Earnings Season Begins

The top three sectors that are expected to offer strong results with potential “upside surprises” for Q4 ’16:

  • Energy
  • Technology
  • Financials

Energy should have the best “upside” in terms of Q4 ’16 earnings growth simply because I suspect the Energy companies have been shrinking their P/L’s the last 8 quarters. which should give the sector nice leverage as expected Q4 ’16 revenue growth for the Energy sector is expected to be the strongest in 2 years. Cash-flow and free-cash-flow should also be a positive story for the sector. Don’t forget it was Q1 ’16 where basically, the profits for the entire Energy sector were wiped out, with the drop in crude oil from $40 in November ’15 to $28 by mid-January ’16, so the sector should see a few quarters of potential out-performance relative to the rest of the market. (Clients are long XLE, IYE, OIH). The price of crude oil has now doubled in the last 12 months.

The downside ? This cross-border tax could be potential headache or worse for Energy. I’m trying to get up to speed on and listening to and reading all that I can about what this means coming from the House, Speaker Ryan and the Ways and Means head Brady.

Technology: Apple should have a better quarter than many suspect. Expectations are pretty muted coming into the quarter. IBM is one of the favorites. It is one of the “low expectations, high potential” stocks for clients for 2017. Technology sector revisions have been mainly positive for the sector since late August, early September, when Apple surprised the Street with strong pre-sale comments around iPhone 7. The real catalyst – if it should happen – will be with any reasonable repatriation and tax reform which might not happen until mid-2017. Tech has gotten off to a strong start in 2017, the best start in early January in the last decade, but I’d rather see earnings reports and higher estimate revisions. Microsoft is client’s largest Technology position. It is a classic GARP stock and is the #2 Cloud player second only to AWS (Amazon Web Services).

The downside ? The trade treaties, immigration changes that might impact H1-B visa’s, and any delay or change to the expected tax repatriation of these enormous cash balances held overseas.  (Long MSFT, IBM, AAPL, and overweight Tech)

In 2016, the SP 500 rose roughly 11.5%, while the Nasdaq and Nasdaq 100 rose 7.5% and 5.89%v respectively. I’m sure Apple was a big part of that relative performance drag.

Financial: JP Morgan (JPM), Wells Fargo (WFC) and Bank of America (BAC) report Friday morning, January 13th, before the bell. The stocks have really run since November 8th. The Financial sector rose 22% in calendar 2016, and the great majority of that came in the 2nd half of 2016 and the greater majority of that 2nd half lift came after November 8th. JPM is our favorite of the three banks and our only long. JPM has the right combination of traditional lending and capital markets. Plus, after the London Whale, you’d have to suspect Jamie Dimon isn’t keen to repeat sins of the past. JPM has risen $20 in price just since November 8th, ’16. A pullback to the low $80’s would be a great opportunity.

While Dodd-Frank reform could be great for the banks, I hope it isn’t repealed entirely.

Client’s largest financial holding is Schwab (SCHW), which deserves a separate post. Client’s largest financial positions are Schwab (SCHW), JP Morgan (JPM), Chicago Merc (CME) and Goldman Sachs (GS).

The downside to Financial sector ? Rates rise too quickly, President-elect Trump goes off the deep-end on some of his economic policies, tax reform doesn’t happen. The US Financial sector is a “function” of the US economy, not a driver of it like technology. Some pundits have said that “corporate lending” was stifled by Dodd-Frank. If you look at the numbers from the big banks corporate lendin g has been a pretty consistent area of strength the last year. Corporate lending has been growing 10% -12% from the numbers I see when updating fundamentals. My impression of Dodd-Frank was that it basically killed off the trading desks (amongst other activities) at a number of large and larger regional banks, thus hurting revenue and earnings growth. That may not be a bad idea for some banks.

This was a very broad brush before earnings start Friday, 1/13 and next week. Use ETF’s to play the sectors if individual stocks arent right for you.

Positions and opinions can change any time.

Thanks for reading…

 

 

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