As of late December, earnings growth for 2018 was expected at 20.3%, the highest since 2010 and the highest revenue growth (expected 8.9%) since 2011. Profit margins surged last year with the S&P average of 12% reached in the third quarter the highest since Factset began tracking the data in 2008.

But the stock market is forward looking and investors don’t like what they see in 4Q and beyond.

Trade wars, dollar headwinds, and a host of other geopolitical risks conspired together to send the market into bear territory in December.

#-ad_banner-#Fourth quarter earnings reports are scheduled to ramp up starting the week of Jan. 14, and this might be the most important quarterly earnings in a decade. Management guidance on 2019 expectations could either calm worried investors or send the market back into a tailspin.

Will last year’s selloff end up being a buying opportunity or just a warning to get out before the real pain?

Bulls Stampede As The Bear Growls
Investors seem to have finally scaled the Wall of Worry everyone talks about and what they saw caused a panic. Despite a brief bounce, the S&P 500 is still down 17% from its September high.

According to Factset Research, estimated earnings growth for S&P 500 companies in the fourth quarter is 12.4%, which would mark the fifth consecutive quarter of double-digit earnings growth. But that’s where the good news comes to a grinding halt.

Analysts have become increasingly bearish on the outlook with all 11 sectors seeing earnings downgrades since Sept. 30 when 4Q growth was expected to top 16.6% on a year-over-year basis.

The outlook for 2019 isn’t so rosy either with analysts expecting earnings growth of just 7.9%, down nearly a quarter from estimates for growth of 10.4% at the end of September.

Despite the weakness in expectations for year-over-year growth, earnings are still expected to rise this year, and the underlying economic picture should support higher prices. GDP growth in the United States is expected to top 2.3% and unemployment remains at multi-decade lows.

Off this base-case scenario for growth, the greenback could weaken and provide a further tailwind for stocks. Dual deficits and the potential for the Fed to hold off on interest rate hikes could see the dollar fall from its position of strength last year.

A de-escalation of the trade war with China would also be a significant boost to sentiment. President Trump and Xi have until March to find a face-saving arrangement and neither wants the kind of market chaos that could come from a failure in negotiations.

Sectors That Could See A 4Q Earnings Boost And Beyond
It’s quite a bit easier to find value in the market than it was just a few months ago, but three sectors in particular strike me as especially good deals.

Every sector has seen earnings estimates reduced but some have really seen sentiment turn negative. Many of the names in these sectors are trading in value territory and the best-of-breeds could provide relative safety if we do see a recession.

Companies in the materials sector have seen the third largest decrease in expected 4Q earnings growth among analysts with 79% of companies having their earnings estimates cut since September. The sector is now expected to report just 9.1% earnings growth from 4Q 2017 versus expectations for growth of 17.7% previously.

The sector has been one of the hardest hit with the Materials Select Sector SPDR (NYSE: XLB) falling 12.8% over the last quarter. The group now trades for 13.3 times estimated 2019 earnings, a discount of 13% on the 10-year average multiple of 15.3 times and a 17% discount on the five-year average multiple.

Olin Corporation (NYSE: OLN) is a leader in chlorine derivatives and epoxies and No. 1 in many of its markets. However, Olin also has the Winchester firearms division which makes little strategic sense.

Pricing in chemicals has been weak over the last few years but is turning and the company could see a turnaround this year. Shares trade for just 10 times earnings, a discount compared to peers, and earnings are expected 12% higher over the next year. The estimate for earnings per share of $0.39 in the fourth quarter has been sliced from expectations of $0.50 per share just two months ago.

Besides the fundamental value and 3.9% dividend yield, I would not be surprised if the Winchester segment is sold or spun off sometime in the future to allow management to focus on strategic areas. The division accounts for just 10% of sales and 5% of earnings and a sale could unlock significant value for shareholders.

Companies in the consumer staples sector have also seen consensus earnings slashed, from expected growth of 6.7% at the beginning of the fourth quarter to estimates for just 2.7% year-over-year growth as 4Q reports start coming out.

The defensive nature of the sector has helped stocks with a relatively mild 5.8% decline in the Consumer Staples Select Sector SPDR (NYSE: XLP) over the last three months. The sector now trades for just 16.8 times estimated 2019 earnings, just over the 16.6 times average multiple over the last decade and a discount of 12% on the average multiple over the last five years.

General Mills (NYSE: GIS) is a behemoth in consumer foods with three of the top five cereal brands, controlling 30% of the market, and 18% of the domestic yogurt market. The company controls 50% of the market for baking mixes, 40% in grain snacks and closed its acquisition of pet food manufacturer Blue Buffalo early last year.

Shares trade for 12.4 times trailing earnings with a modest 1.3% growth in EPS expected over the next year. The company has beaten expectations in 10 of the last 12 quarters with an average beat of 6.9% over the period. Expected earnings for 4Q of $0.69 are down slightly from an estimate of $0.71 per share 30 days ago.

The relatively modest cut in expectations for the healthcare sector, with 4Q earnings now seen at 10.5% versus expectations for growth of 11.7% previously, hasn’t saved stocks in the Health Care Select Sector SPDR (NYSE: XLV) from falling 9.1% over the last three months.  The sector now trades for 14.4 times estimated 2019 earnings, just over the 14.0 times average multiple over the last decade and a discount of 10% on the average multiple over the last five years.

Cardinal Health (NYSE: CAH) is the third-largest pharmaceutical distributor as well as a strong player in the medical equipment space. Consolidation has been the trend in healthcare and just three firms — Cardinal, AmerisourceBergen, and McKesson — control 90% of the distribution market. Walgreens was in talks with AmerisourceBergen early last year about an acquisition and it might not be too long before rumors swirl around an acquisition of Cardinal Health.

Shares trade for just 8.5 times earnings though EPS is expected 5.8% lower to $4.90 a share over the next four quarters. The company has beaten expectations by an average of 12% in 11 of the last 12 quarters though so actual earnings reported could be much higher.

Earnings estimates for the fourth quarter of $1.61 have come down from expectations for $1.64 per share 30 days ago and the shares pay a solid 4.2% yield.

Risks To Consider: Company-specific weakness can still weigh on shares even if sector-level tailwinds from better-than-expected earnings support the group. Position in best of breed names that should do well on their own.

Action To Take: Position ahead of 4Q earnings in sectors that could surprise the market on higher-than-expected earnings and provide support to the stocks within the group.