Energy and Materials Will Ride High This Earnings Season. . .but 2012 is Another Story

The hottest sectors for the Q311 earnings season, energy and materials, should stay on their winning streak through the next quarter, but will get hit by lagging demand from emerging markets in 2012.

The two sectors will report the best results in an earnings season expected to see overall profits by companies in the Standard and Poor's 500 Index rise by 12.6%, with energy up 43% and materials up 32%.

Demand for both should remain strong enough in the fourth quarter to give energy a 25% pop and materials a 22% jump. But after that, slowing activity in emerging economies, particularly China, will take its toll.

"If you look at the last few quarters, any time companies are talking about where they're seeing the largest growth in sales and earnings, it's typically been China, India, emerging markets," John Butters, senior earnings analyst at FactSet Research Systems Inc. (NYSE: FDS), told Yahoo! Finance. He said that a slowdown in demand would have an "impact on future expectations."

Just last week the price of such commodities as oil, copper and other metals fell when China reported that its trade surplus fell to $14.5 billion (B) in September, down from $17.7B in August.

"The concern is that the European debt crisis is hampering the economy in China, and possibly in broader Asia," Bart Melek, head of commodity strategy with TD Securities, told The Wall Street Journal. Investors, he said, "think demand may drop."

Meanwhile, the International Energy Agency (IEA) cut its oil demand forecasts for 2012, though the organization still sees oil demand hitting a record this year.

Q311 Earnings Season

Apart from energy and materials, the Consumer Discretionary Sector will also do well with 16% growth in the third quarter. The laggards this quarter will be the Utilities sector, which will see earnings fall 1%, Healthcare, which will eke out 2% growth and consumer staples, which will see 5% growth.

Yet the overall message is a positive one.

"Overall we are seeing fairly broad-based growth across the sectors," Butters told Yahoo! Finance. "Nine of the ten sectors are expecting growth on the earnings side and all 10 sectors are expecting growth on the revenue side."

For Q411, most sectors will see a decline in growth except for Financials, which will see a 101% increase. That's not quite as exciting as it sounds, as it will mostly come from the comparison to the huge losses suffered by American International Group (NYSE: AIG) last year. Without AIG, Financials are expected to see 17% growth.

For the S&P 500 as a whole, Butters sees earnings growth rising to 20% in the fourth quarter, but dropping to 9% in the Q112.

Surprises to the Upside

Analysts also anticipate a lot of upside surprises over the course of the third quarter earnings season—partly because expectations have been lowered 4.4% since the beginning of the quarter but also because many companies have found ways to grow despite the lousy U.S. economy.

Of the two dozen or so companies that have reported earnings so far, over 70% have beaten expectations, which is consistent with the past several quarters and likely to continue through the rest of the period.

Ordinarily a stream of positive earnings reports would push the markets higher, but lingering concerns over the anemic U.S. recovery and the debt crisis in Europe have lowered guidance for 2012.

"As the rallies of the past few weeks show, investors would not ignore convincing steps from officials to diffuse sovereign debt risks in Europe," Citigroup (NYSE: C) economist Steven Wieting wrote in a note to clients. "But in the absence of such steps, reasonably solid earnings reports would most likely provide only a temporary respite from macro-driven markets."

As for the sectors that could produce the biggest surprises this earnings season, Mike Jackson, founder of investment firm T3 Equity Labs, list industrials first, followed by utilities, financials, consumer staples and information technology.

"You've got the true driver of the market (earnings) continuing to go forward and the market going south. That's unusual," Jackson told Reuters. "There's a fairly good chance of surprise at the index level and at the sector level."