Global growth worries have been a recurring theme in market discourse lately. But the focus of these worries was primarily on uncertainty about China and other emerging economies. Even the Fed cited these global growth challenges as a key reason for not announcing interest rate increases at the last FOMC meeting. While questions remained about the timing of the first interest rate increase, which a number of Fed officials indicated will arrive at the one of the two remaining meetings this year, there was no doubt about the state of the U.S. economy. In the consensus narrative, the U.S. economy stood as a pillar of strength and stability in an otherwise unsettled world.

That favorable narrative about the U.S. economy took a body blow with the September non-farm payroll report that shows the economy losing steam during the Summer months. Estimates for third quarter GDP growth have been steadily coming down lately, with the Atlanta Fed’s (almost) real-time measure of the economy currently pegging Q3 GDP growth at only +0.9% -- and that was prior to the jobs disappointment.

It could all be just a temporary setback caused by inventory unwind (heavy inventory build in Q2 needs to be worked through in Q3) and weak trade numbers as a result of global weakness. But the fact is that we don’t know – we simply don’t know how enduring or otherwise this period of soft data will turn out to be. What is less uncertain is the fact that the Fed proved itself quite prescient in taking a pass on raising interest rates at the last meeting. The market’s Fed expectations have shifted materially following the weak jobs reading, with many now seeing the first rate increase sometime early next year.

The Fed and the state of the economy will remain the market’s primary preoccupation through the rest of this year, but this week’s start of the Q3 earning season will put a spotlight on the weak corporate earnings picture as well.

We know that the growth picture was quite bad in Q2, with total earnings for the S&P 500 index down -2.2% from the same period last year on -3.5% lower revenues. The Energy sector was the primary reason for the aggregate decline – the growth picture improves once the Energy sector is excluded from the aggregate numbers. Excluding Energy, total earnings for the S&P 500 index would have been up +5.1% in Q2 on +1.2% higher revenues.  

The growth picture isn’t expected to improve in Q3 either, with total earnings for the S&P 500 index expected to be down -5.6% from the same period last year on -5.5% lower revenues. The headwinds from Q2 are at play in Q3 as well, with a combination of Energy sector weakness, dollar strength and global growth uncertainties weighing on the outlook. Excluding the drag from the Energy sector (Energy sector earnings expected to be down -65.4% year over year), total earnings for the index would be up +1.6% on -0.5% lower revenues.

Including the Alcoa (AA - Analyst Report) report on Thursday, we will be seeing Q3 results from a total 24 companies, of which 5 are S&P 500 members. The chart below shows the weekly reporting calendar for companies in the S&P 500 index.

Stand-out Sectors in Q3

Energy stands out for the wrong reasons, as briefly mentioned earlier, but it is hardly the only one with negative earnings growth in Q3. In fact, 8 of the 16 Zacks sectors are expected to have lower earnings in 2015 Q3 relative to the year-earlier period, with Industrial Products (earnings decline of -23.4%), Conglomerates (-15.2%), Basic Materials (-18.4%), and Consumer Staples (-5.6%) as the big decliners.

On the positive side, the Finance sector is expected to have another good quarter, with total earnings for the sector expected to be up +7.5% after the +7.2% gain in the preceding quarter. A big part of the Finance sector gains this quarter are due to easy comparisons at Bank of America (BAC - Analyst Report). Excluding Bank of America, the sector’s growth drops to less than 1%. Other sectors with positive earnings growth in Q3 include Transportation (earnings growth of +17.0%), Autos (+21.2%), Construction (+7.5%) and Medical (+8.0%). Total earnings for the Technology sector are expected to be up +1.7% from the same period last year, but the sector’s growth rate drops into negative territory once Apple’s (AAPL - Analyst Report) strong contribution is excluded from the numbers.

The table below presents the summary picture for Q3 contrasted with what companies actually reported in the 2015 Q2 earnings season.

Looking Beyond Q3

The chart below shows current consensus earnings growth expectations for the coming quarters contrasted with what is expected for Q3 and what was actually achieved in Q2. As you can see, this year has effectively been washed out, with growth expected to resume early next year and accelerate from there onwards. Total earnings for the S&P 500 index are effectively flat this year, but are expected to be up in double-digits next year.

Economists define two back-to-back quarters of negative GDP growth as a recession. If the Q3 earnings growth rate stays in the negative territory as currently projected, then we will be well within out rights to call it an earnings recession. As you can see in the above chart, analysts expect the earnings growth picture to start turning around next year and really accelerate towards the back-half of 2016.

The relatively optimistic looking expectations for the outer periods aren’t unusual – Wall Street analysts always tend to be more optimistic about the future. But estimates start coming down as the period in question comes closer. The erosion of 2015 growth estimates was driven largely by what happened to the Energy sector. But estimates for other sectors came down as well…and we will likely see something similar to current 2016 estimates as well.

Here is a list of the 24 companies reporting this week, including 5 S&P 500 members.