Health Care Top Sector Performer

The second-quarter earnings season is quickly coming to a close. Starting unofficially with Alcoa on July 8, more than 90 percent of firms in the S&P 500 have since reported their profit figures, giving the latest glimpse into the health of corporate America.

Earnings are far and away the most widely followed financial metric on Wall Street. A firm's profits and growth are typically what dictate its stock performance, at least in theory.

Of course, there are many other factors that analysts consider, not the least of which is valuation. A company growing by leaps and bounds could have an overvalued stock, while the stock of a lower-growth company could be undervalued.

Still, even though they should not be looked at in isolation, earnings provide key insight into which companies and which industries are doing well (and vice versa).

In aggregate, the earnings for the S&P 500 companies are on track to have declined by about 1.5 percent from a year ago during Q2. That's the first year-over-year decline since the third quarter of 2012.

Huge Drag From Energy

Fortunately, the drop in earnings didn't seem to come from any economywide weakness. Rather, it was the result of a massive 44 percent plunge in crude oil prices, which decimated energy sector profits. In fact, energy is the only sector with negative growth in the quarter.

Source: Bloomberg

Q2 earnings for the sector dropped 58 percent from last year, fueling intense weakness in energy stocks. The Energy Select SPDR (XLE | A-95), an ETF that tracks the energy portion of the S&P 500, is unsurprisingly the worst-performing of the major sector funds.

XLE has dropped 4.6 percent since the start of earnings season and 11.2 percent since the start of the year. In those same time frames, the SPDR S&P 500 (SPY | A-98) has returned 2.4 percent and 2.8 percent, respectively.

YTD Returns For XLE, SPY

Top Sectors

In contrast to energy's dismal quarter, each of the other nine major sectors saw an improvement in their earnings from last year. Telecom services was the best group, with growth of 9.8 percent. Telecom is a relatively small sector within the S&P 500 made up of only five companies and dominated by two: Verizon and AT&T.

Despite the strong earnings, investors haven't been bidding up the sector. The Vanguard Telecommunication Services ETF (VOX | A-70), which holds firms in the industry, hasn't performed as well as one might expect. The fund is up 2.8 percent since the start of the year, and 1.9 percent since the start of earnings season, roughly in line with the S&P 500.

Following telecom are three other sectors that saw earnings growth between 8 and 9 percent during Q2: consumer discretionary, utilities and health care.

Consumer discretionary, a cyclical industry that tends to outperform when the economy is doing well, has been a beneficiary of the moderate but steady growth in GDP.

The Consumer Discretionary Select SPDR (XLY | A-92), which holds a varied basket of companies, advanced 2.8 percent during earnings season and 9.3 percent on a year-to-date basis, soundly beating the broader market.

XLY's top holdings include firms such as Walt Disney Co., Amazon.com, Comcast and Home Depot.

Health Care Top Performer
Health care is another sector that has outperformed the broader indexes this year. The Healthcare Select SPDR (XLV |A-94) advanced 11 percent year-to-date and 2 percent during earnings season.

That year-to-date figure is the best of any sector. Increased spending due to the Affordable Care Act, better known as “Obamacare,” as well as favorable demographic trends, have bolstered profits for health care companies.

Meanwhile, the Utilities Select SPDR (XLU | A-86) has underperformed the market this year. The ETF lost 1.8 percent year-to-date, though it's made a comeback during the earnings season, rising 5.5 percent in the period since July 8. Perhaps the strong Q2 earnings for the sector have attracted some investors.

It's also worth noting that utility stocks usually have relatively high yields, thus, in the short term, they may be more in tune with fluctuations in interest rates than earnings. After rising early in the year, interest rates have been falling recently, which has undoubtedly helped XLU rebound.

YTD Returns For VOX, XLY, XLV, XLU, SPY

5 Sectors With Low Single-Digit Growth

Coming in with growth at the lower end of the range were five sectors, including technology, materials, financials, industrials and consumer staples.

For materials and industrials, the story was one of weak global growth and a strong dollar. As Praxair, one of the top five holdings of the Materials Select SPDR (XLB | A-80), explained in its recent earnings release, results "were challenged by negative impacts from foreign currency translation, as the U.S. dollar remained strong against most foreign currencies."

The company also cited head winds from "weaker underlying industrial activity in Brazil and China and ... weaker metals, energy and manufacturing in the United States."

Unsurprisingly, both XLB and the Industrials Select SPDR (XLI | A-91) have lagged this year, dropping by 5.1 percent and 3 percent, respectively. Since earnings season began, XLB fell 2.5 percent, while XLI advanced 1.7 percent.

For tech, financials and consumer staples, the performance has been better. The Technology Select SPDR (XLK | A-90) returned 3.5 percent year-to-date, all of that coming since the start of earnings season. Strength in tech heavyweight such as Google and Facebook have been somewhat offset by underwhelming results from Apple, but the industry is still very much a hot area for investors.

Financial Bounce Back
An area that is not nearly as exciting is the financial sector, where regulations put in place since the Great Recession have dampened enthusiasm. Still, the Financial Select SPDR (XLF | A-90) has performed roughly in line with the broad market, with a 2.9 percent year-to-date gain. A 4.5 percent surge since earnings season began has helped put the sector back in the green.

Bank of America, one of the top holdings of XLF, cited "core loan growth, higher mortgage originations and the lowest expenses since 2008" for its earnings beat during the quarter.

Rounding out the 10 major sectors is the consumer staples group. These relatively "boring" but stable companies tend to underperform during the good times and outperform during the bad times. In Q2, the sector saw the lowest growth rate outside of energy.

Even so, the Consumer Staples Select SPDR (XLP | A-94) has outpaced the S&P 500 this year, perhaps due to safe-haven buying amid the multitude of concerns out there about the global economy and particularly China. XLP is up 4.7 percent year-to-date and 3.3 percent since the start of earning season.

YTD Returns For XLB, XLI, XLK, XLF, XLP, SPY

Looking Ahead

The second quarter is, of course, just one of four quarters in the year and is not necessarily representative of 2015 as a whole. Indeed, analysts expect earnings for the S&P 500 to rebound from Q2 lows and finish solidly in positive territory when all is said and done, with growth of 5.3 percent expected for this year based on current estimates.

Source: Bloomberg

That said, one area where there's not expected to be any improvement this year is the energy industry. With crude oil hitting new six-year lows in recent days amid oversupply concerns, earnings will likely remain in a funk. Full-year 2015 analyst estimates suggest that profits for the sector will end up 53 percent lower than last year.

On the other end of the spectrum is health care. While Q2 was strong, it's nothing compared with the acceleration in growth expected in the second half of the year. In fact, health care earnings for the full year are anticipated to be a stunning 36.4 percent higher than last year.

The tech sector may also see improvement later in the year, with earnings growth of 16.4 percent expected for the calendar year. That's followed by 13.6 percent growth for telecom and 12 percent for consumer discretionary.

In the low- to mid-single-digit range are the other industries: industrials, financials, utilities, materials and consumer staples.

Contact Sumit Roy at [email protected].