The first quarter earnings season is all but over, with just a handful companies having not reported.

We can draw a couple of conclusions about the results. First is that there is a serious dichotomy between growth as measured by the median EPS growth rate and as measured by the total net income growth. The median EPS growth rate is fairly healthy, while the total net income reported is sharply below a year ago. More companies are posting positive surprises than disappointments, although the margin is slightly less than we have seen in the past. It is also clear that there seem to be two markets, with part of the economy continuing to enjoy very robust earnings growth, while other parts, chiefly the Financials, are having a down right awful earnings season.

Let's first look at the good news. The median year over year EPS growth rate is 9.0%, and six of the ten sectors are posting double-digit gains. While that is short of the sort of double-digit growth in median EPS that we saw quarter in and quarter out for many years, it is far from the end of the world. The median expectation for the handful of firms yet to report is for 5.7% growth. Assuming that those companies surprise by the same margin as the firms that have already reported (median surprise of 3.03%), we will see the current number stay right around where it is now, or even dip slightly.

The ratio of positive to negative surprises is running at 2.3:1. Not as good as in the past (over 3.0 is normal in recent years), but comfortably above 1.0. Only the Financials are posting more disappointments than positive surprises, and there just barely. The Financials have been responsible for 32.1% of all disappointments, even though they are responsible for only 18.9% of the total firms reporting.

On the other side, the ratio of positive surprises to disappointments is running at very high levels in Health Care (5.43) and Industrials (5.50). Energy, with a surprise ratio of 3.00, has the second highest median surprise, at 7.23%. Telecom has the best median surprise at 8.00%, even though its surprise ratio is just 1.67. However, given the very small number of firms in the Telecom sector (9), medians of any sort are less meaningful than sectors with large numbers of firms in them.

In terms of year-over-year growth, Energy is the clear winner, with half the Energy firms reporting year over year EPS growth in excess of 29.3%. Since all the energy firms have their numbers in, that number will not change. Tech holds the silver with 21.5% growth, while Industrials hold the bronze at 17.4%. Honorable (double-digit) mentions go to Telecom, Health Care and Staples. Financials and Discretionary are both posting negative growth, while Materials and Utilities were barely positive.

With the first quarter season over, it is time to turn our attention to the second quarter expectations. The bar is not set very high with the EPS at the median firm expected to be just 5.56% higher than a year ago. After factoring in the probability that there will be more positive surprises than disappointments, it most likely means that median year-over-year EPS growth for the S&P 500 as a whole will be around 8.0%. By sector, the broad outline suggests that the second quarter should be very similar to the first quarter. Energy and Tech are currently to again hold gold and silver, respectively, and Health Care may nudge out the Industrials for the Bronze. Financials and Consumer Discretionary are expected to again bring up the rear, with performances that are even worse than in the first quarter.

Keep in mind what the median measures. It is a gauge of what the 'normal' firm will report in terms of EPS. It is not influenced significantly by extreme data points, and implicitly treats the results from Exxon Mobil (XOM), General Electric (GE) and Wal-Mart (WMT) the as being just as important as the results for Murphy Oil (MUR), Manitowoc (MTW) and Big Lots (BIG). Changes in shares outstanding, due to buybacks or new issuance also affect the results in this measure, while they do not affect total net income.

Fourth-Quarter Scorecard
Sector	Q1 Median Growth Rep.	Q2 Median Proj. Growth.	2007 Median Rep. Growth	2008 Median Proj. Growth	% Reported	Median % Surprise	# Pos Surprise	# Neg Surprise	# Match
Energy	29.32%	18.39%	12.35%	19.72%	100.00%	7.23%	24	8	4
Tech	21.53%	16.03%	15.57%	14.46%	98.59%	3.77%	48	13	9
Industrial	17.42%	11.11%	16.22%	13.83%	98.21%	3.95%	44	8	3
Healthcare	14.40%	12.24%	16.55%	12.71%	100.00%	4.48%	38	7	6
Telecom	13.85%	10.43%	-2.94%	8.44%	100.00%	8.00%	5	3	1
Cons. Stap.	10.81%	8.57%	11.42%	9.62%	97.44%	2.77%	24	8	6
Utilities	2.63%	4.35%	9.09%	5.78%	100.00%	2.56%	17	13	1
Materials	2.59%	6.79%	11.52%	8.38%	100.00%	2.36%	18	8	2
Cons. Disc.	-5.00%	-9.76%	7.27%	3.18%	95.40%	2.78%	48	22	13
Financial	-9.95%	-12.72%	0.87%	-0.56%	100.00%	0.00%	41	42	9
S&P 500	9.09%	5.56%	11.79%	9.62%	98.60%	3.06%	307	132	54

Yet-to-Report
Sector	Q1 Proj. Growth	Q2 Proj. Growth	2007 Proj. Growth	2008 Proj. Growth
Energy	24.39%	7.10%	18.26%	8.98%
Tech	20.00%	19.89%	19.45%	17.95%
Industrial	15.53%	12.22%	14.21%	13.77%
Healthcare	13.51%	15.56%	13.24%	14.45%
S&P 500	11.90%	10.39%	12.55%	12.96%

Total Net Income Growth

Turning now to the 'worst of times' in this tale of two markets. The total net income reported is 18.7% below the total net income that those same 493 firms reported in the first quarter of 2007. (This is an improvement from the 22.9% drop they reported in the fourth quarter.) Specifically, those firms reported $170.8 billion in net income (before non-recurring items) this year and $210.2 billion last year.

The Financials have been responsible for more than the entire drop in net income though. Total earnings in the sector are off 81.1% to $11.3 billion versus the $59.4 billion they reported a year ago. That is a drop of $48.2 billion vs. a drop of just $39.4 billion for the market as a whole. Put another way, if the Financials are excluded, then total net income is actually up 5.9%. While still below the median growth number (which would be 11.43% if the Financials were excluded) it is much less than the yawning chasm at the full S&P numbers show. The actual picture is some what worse than that for the Financials since some of there problems have been taken in the form of one time extraordinary charges, or have not even shown up on the income statement (just hits to the balance sheet taken in other comprehensive income).

Let's put what is happening to the Financials another way. At this point in the earnings season last year, the Financials had earned more than the next two highest sectors (Energy and Health Care) with the Telecom sector thrown in for good measure. This year they are in sixth place, behind Energy, Health Care, Industrials, Tech and Staples. The sector's earnings only exceed the small Telecom, Materials, and Utility sectors, all of which in normal times provide less than 4% of total earnings each, and the Discretionary sector, which is both hurting itself, and which tends to be highly seasonal (most retailers are in the sector). On the other hand, in the fourth quarter, Financials were dead last as the sector as a whole was bleeding red ink. Put another way, last year, the Financials gathered 28.5% of all the earnings in the S&P 500 in the first quarter, this year they were responsible for just 6.6%. Energy on the other hand was responsible for 21.0% of all first quarter earnings this year up from 13.6% a year ago.

The biggest earnings gains in the first quarter were in the Energy sector, with total net income 25.6% above last year, and in the Material sector, with a gain of 14.3%. Tech holds the bronze with growth of 14.0%and is the only other sector to post double digit growth on a total net income basis. While the Financials are clearly the core of the problem in terms of weak earnings, it has not been a good quarter so far for the Durables (down 37.9%). Health Care is up just 3.8%, a very significant slowdown from the 17.9% growth it showed in the fourth quarter.

Turning to the expectations for the second quarter, it looks ugly, but not quite as ugly as in the first quarter. The total net income for the S&P 500 is currently expected to be 9.8% below the second quarter of 2007. This improvement over the 18.7% decline in the first quarter is almost entirely a function of things being just ugly and not downright disastrous in the Financial and Discretionary sectors, which are expected to be down 41.6% and 25.0%, respectively. Not exactly a cause for celebration to my way of thinking. This is particularly true since three months ago, the expectations were that total net income would decline by 5.1% in the first quarter for the S&P 500, due in large part to declines of 31.5% in the Discretionary sector and a 24.8% decline in the Financials.

Meanwhile, all of the top five sectors in the first quarter are expected to see their growth rates drop by more than 5.0% (relative to the first quarter) in the second quarter. Energy is expected once again to lead the total net income growth race, but with only a 10.3% gain, down from 25.6% in the first quarter. Five sectors are expected to post lower total net income in the second quarter of 2008 than they did in the second quarter of 2007.

Total Net Income Growth (Reported)
Sector	Q3 Rep. Growth	Q4 Rep. Growth	Q1 Rep. Growth	Q2 Proj. Growth	2007 Rep. Growth	2008 Proj. Growth	2009 Proj. Growth
Energy	-11.45%	23.05%	25.62%	10.25%	10.81%	18.55%	5.93%
Materials	12.09%	-3.71%	14.25%	-2.50%	6.67%	11.51%	12.71%
Technology	17.53%	29.68%	13.98%	8.62%	11.30%	19.83%	17.87%
Utilities	5.92%	13.21%	8.90%	-0.85%	10.59%	6.70%	10.43%
Industrials	7.69%	5.83%	7.30%	1.99%	10.16%	8.99%	13.00%
Cons. Stap	6.92%	6.46%	5.10%	7.86%	6.99%	13.64%	10.48%
Health Care	15.76%	17.16%	3.83%	4.26%	19.52%	7.96%	11.06%
Telecom	29.19%	31.66%	1.41%	-1.14%	18.75%	2.16%	10.37%
Cons. Disc.	-16.18%	0.77%	-37.88%	-21.78%	0.61%	-1.05%	27.80%
Financials	-21.06%	-121.66%	-81.06%	-41.63%	-35.56%	-6.66%	46.95%
S&P	-2.25%	-22.86%	-18.71%	-9.48%	-2.63%	8.24%	18.26%

Total Earnings Growth: Yet-to-Report
Sector	Q3 Rep. Growth	Q4 Rep. Growth	Q1 Rep. Growth	Q2 Proj. Growth	2007 Rep. Growth	2008 Proj. Growth	2009 Proj. Growth
Telecom	32.42%	29.19%	29.72%	9.89%	18.04%	11.62%	10.70%
Technology	16.27%	18.45%	20.31%	12.43%	12.51%	23.32%	16.90%
Energy	6.46%	-7.64%	15.57%	19.06%	6.12%	13.55%	0.98%
Healthcare	9.93%	17.64%	11.79%	1.55%	20.51%	10.64%	11.88%
S&P	11.30%	-1.79%	-8.30%	2.41%	2.47%	15.40%	11.04%

Total Earnings Growth: Combined
Sector	Q3 Rep. Growth	Q4 Rep. Growth	Q1 Rep. Growth	Q2 Proj. Growth	2007 Rep. Growth	2008 Proj. Growth	2009 Proj. Growth
Telecom	32.42%	29.19%	29.72%	9.89%	18.04%	11.62%	10.70%
Technology	14.47%	17.58%	19.43%	12.06%	12.24%	23.19%	17.66%
Energy	6.46%	-7.64%	15.57%	19.06%	6.12%	13.55%	0.98%
Healthcare	9.93%	17.64%	11.79%	1.55%	20.51%	10.64%	11.88%
Utilities	15.63%	6.30%	6.71%	-3.69%	10.98%	7.62%	11.18%
Industrial	12.40%	7.37%	2.83%	15.95%	10.20%	12.89%	14.98%
Cons. Stap.	7.37%	6.92%	2.15%	10.27%	8.39%	9.13%	10.61%
Materials	15.98%	12.96%	1.36%	14.87%	8.14%	11.14%	5.82%
Cons. Disc.	-2.67%	-13.21%	0.97%	-5.55%	0.86%	13.75%	18.61%
Financials	16.63%	-20.34%	-66.91%	-13.88%	-16.31%	20.09%	11.31%
S&P	11.40%	-1.10%	-11.31%	2.78%	2.80%	14.99%	11.26%

The Zacks Revisions Ratio

To help gauge the direction of the market, we take note of what analysts are thinking. By tallying their EPS changes, we can determine our 'revisions ratio'. This ratio simply divides the total number of positive estimate revisions by the total number of estimate cuts. Thus, a high ratio is a bullish indicator and a low ratio is bearish. For the S&P 500 as a whole, a number below 0.80 or above 1.25 is generally significant. For individual sectors the distance from 1.0 should be greater for the numbers to be significant.

The revisions ratio dropped slightly after several weeks of improvement. It is now at 1.10, a reading that we generally consider neutral. With positive surprises running more than two to one over disappointments, one should expect to see more increases than cuts in full year expectations. After all, first quarter earnings are part of full year earnings, thus if a firm reports higher than expected earnings for the quarter, and the analyst does not raise his full year numbers by the amount of the beat, he is implicitly cutting his estimates for the rest of the year. There has not been much movement in the ratio in recent weeks, with the ratio falling to 1.10 from 1.14 last week and 1.08 two weeks ago.

The overall pace of estimate revisions is past the peak for this quarter. Over the last four weeks there have been 2,027 changes in estimates: 1,061 up and 966 down, down 39.1% from 3,326: 1,775 up and 1,551 down last week. The ratio of firms with rising mean estimates to falling mean estimates is 0.98, slightly below the revisions ratio, and in neutral territory. Six sectors are in positive territory. The Materials sector was the weakest this week, finally displacing the Financials and the Discretionary sectors from the cellar. In Materials, paper was pummeled (International Paper (IP), Mead-Westvaco (MWV), and Weyerhaeuser (WY)).

The Energy sector again topped the chart this week with a revisions ratio of 2.53. The general story is: Upstream good, downstream bad. Noteworthy for their strength were EOG Resources (EOG), Chevron (CVX), National Oilwell Varco (NOV) and Transocean (RIG). The independent refiners like Tesoro (TSO) and Sunoco (SUN) bucked the trend and were weak. As angry as people are about prices at the pump, this is strong evidence that it is the price of crude, not huge downstream (refining and marketing) profits that are the heart of the problem.

Telecom was strong thanks to upward revisions at Century Telecom (CTL) and Windstream (WIN).

Avg. 4wk EPSChange (FY08)	Avg. 4wk EPS Change (FY08)	Revisions Ratio	Firms With FY08 EPS Increase	Firms With FY08 EPS Decrease
Energy	1.25%	1.78	23	11
Health Care	-0.13%	1.05	19	21
Consumer Staple	-0.39%	1.00	15	18
Technology	-4.29%	0.91	26	33
Materials	-0.25%	0.67	9	11
Telecom	-1.08%	0.62	2	7
Industrials	-0.39%	0.58	18	28
Consumer Disc	-3.30%	0.32	19	60
Utilities	-1.99%	0.19	8	13
Financial Services	-5.65%	0.15	19	64
S&P 500	-2.38%	0.49	158	266

The 2009 revisions story is similar to the 2008 story. Although the revisions ratio is below one, it reversed course from an improving trend, falling to 0.90, up from 0.98 last week, and 0.95 two weeks ago. The strongest sector this week was Telecom at 2.55, followed by Energy at 2.05.

The revisions picture for the Financial sector is even worse for 2009 than it is for 2008, coming in at 0.34, or almost three cuts for every increase. Revisions like these will eat away at the robust earnings rebound seen for 2009 (unless 2008 gets cut faster). We do not seem to be getting out of the woods on the Financial sector front. Speaking of woods, they were responsible for the weakness in the Materials sector, with most of the weakness there traceable to forest products companies like WY and IP.

The total number of revisions for the whole S&P 500 for 2009 is also well past its seasonal peak. There were a total of 1,625 revisions: 772 up and 855 down. This is down 38.0% from 2,619 (1,296 up and 1,323 down) last week. The ratio of firms with rising mean estimates to falling mean estimates is 0.84, somewhat weaker than the revisions ratio, and almost into negative territory.

Avg. 4wk EPSChange (FY09)	Avg. 4wk EPS Change (FY09)	Revisions Ratio	Firms With FY09 EPS Increase	Firms With FY09 EPS Decrease
Energy	1.88%	1.88	22	9
Health Care	-0.05%	1.61	21	13
Materials	-0.06%	1.43	9	8
Consumer Staples	0.22%	1.03	12	10
Technology	0.11%	1.00	21	24
Industrials	-0.63%	0.82	19	22
Telecom	-1.67%	0.80	3	4
Utilities	-1.19%	0.42	8	15
Consumer Discr	-1.61%	0.32	27	44
Financial Services	-2.64%	0.19	26	52
S&P 500	-0.77%	0.63	168	201

Market Cap versus Total Earnings

When making investment decisions, growth should always be looked at in conjunction with how much you are paying for a stock. Thus, it makes sense to look at the total earnings expected for a sector, relative to that sector's total market capitalization. This is basically a variation on looking at the P/E.

The chart below shows the share of total earnings for 2007, 2008 and 2009, as well as the share of total market capitalization for each sector (the final bar shown). Since the S&P 500 is a market cap weighted index, this is the same as its index weight. On the chart below, the difference between the sizes of the first three bars shows if a sector is gaining or losing 'earnings share'. The difference between the final bar and the first three bars shows if the sector is selling for an above or below market P/E. If the final bar is smaller than the other bars, the sector is selling for a below market P/E. However, as opposed to just showing the sector P/Es, it also shows the relative importance of the sectors to the overall index.

For years, the Financials were the dominate force in the market, both in terms of market cap, and even more so in terms of total earnings. They have now been dethroned on both counts. Still, despite their current problems, the Financials are still a very significant influence on the market. However, it is now likely that they will lose the earnings crown this year to the Energy sector. Even with all the disasters in the sector, for 2007, the Financials accounted for 22.2% of the total net income for the S&P 500. In 2008, that is currently expected to decline to 16.3% before rebounding to 20.3% in 2009. However, in recent years the sector has accounted for well over a quarter of all earnings.

Energy has usurped the crown this year, with its earnings share climbing to 18.5% from 15.8% in 2007. However, analysts expect a Financials restoration next year, with the sectors share rebounding to 20.3% while Energy slips back to 16.6%. On the market cap (and index weight) front, Tech overtook the Financials 17.0% to 15.7%. Energy, despite being the biggest expected earner for 2008, is only in third place when it comes to index weight at 13.8%. Given the ongoing estimate cuts in the sector, and the estimate increases in the Energy sector, I suspect the Energy sector might just keep its crown in 2009 as well, but that is a long shot prediction.

Keep in mind that these numbers are snapshots, when you should be thinking about a movie. Just three months ago, the Financials were expected to gather 22.0% of all earnings for 2008, and Energy was expected to only get 16.0%. For 2009, the expected earnings shares were 15.0% for Energy and 22.4% for Financials. Over the same time, the market cap share for Financials has slipped from 17.17% to 15.72%, while Energy's share has risen from 12.99% to its current 13.81%.

For many years Financials were clearly the dominate factor in the overall market, despite generally selling for below market P/E's. Based on 2008 earnings, the Financials have a P/E of 14.9x and based on 2009, only 10.1x. However given the pace of estimate cuts in the sector, the true P/E is probably higher since the actual earnings will be significantly lower. Energy has just taken the throne as the cheapest based on 2008 earnings, trading at 11.5x, and 10.8x based on 2009 expectations. The Tech sector is far and away the most expensive in the market, trading for 19.7x 2008 and 16.7x 2009 expectations. Keep your eyes on the revisions. Unless the spreading of economic weakness to the rest of the world causes oil prices to plunge (and the recent trends are very much in the other direction), you can have much more confidence in Energy earnings forecasts actually being achieved (or exceeded) than is true with the Financials.

The S&P 500 as a whole is trading for 15.4x and 13.0x, 2008 and 2009 earnings, respectively. Based on a blend of 67% 2008 earnings and 33% 2009 earnings; that translates to a 6.84% earnings yield, which looks extremely cheap relative to a 4.06% ten year T-note. Even against the AA corporate bond yield of 6.04% it looks attractive. However, the current level of expectations for corporate earnings still implies that profits will stay well above their historical averages as a share of GDP. That would be an exceedingly rare occurrence during a recession. The comparison between the earnings yield on the S&P and the 10 year T-note is in my opinion more a reflection of the extreme unattractiveness of long term T-notes at this point than stocks looking particularly cheap in general, however there are attractive stocks out there. It appears that the flight to quality has caused a massive bubble in the price of T-notes. The prices are hard to justify given the risk that the massive injections of liquidity by the Fed to ameliorate the credit crunch will end up fueling the fires of inflation.



Neil Malkin contributed significantly to this report.
Data in this report, unless stated otherwise, is through the close on Thursday 5/29/2008