Why These Stocks Could Plunge Even Further

Earnings season is over, and the first quarter's results have been largely positive. But the stock market always looks forward, rather than back, so even with a good first quarter in the books, concerns about slowing growth in the second quarter have already played a big role in the market's plunge over the past month -- and could continue to hit certain sectors of the market more than others.

A tale of two quarters
Overall, the first quarter was a nice surprise for earnings. Going into earnings season, expectations were for growth to come in at less than 1%. Yet by the time the dust cleared, 67% of the companies in the S&P 500 had reported upside surprises, with just 23% missing estimates, according to data from S&P Capital IQ. Overall, growth came in at about 7.4%.

That's not to say that every sector performed well. Energy and utilities underperformed, with more companies missing estimates than beating them, and the sectors joined the materials and telecom industries in reporting falling earnings year over year. But excessive strength in industrials, financials, and especially tech helped boost the overall S&P's net income.

As growth continues, however, comparisons get harder. According to the latest estimates, S&P 500 earnings are seen rising less than 0.3% in the second quarter, with seven of the 10 major sectors expected to post earnings declines from 2011's second quarter. Let's take a closer look at the biggest culprits of a possible contraction in earnings when companies start announcing results in July.

Materials stocks have already seen huge losses as fears of slowdowns in China and other formerly fast-growing emerging economies lead to investor pessimism. In particular, iron ore producer Cliffs Natural Resources (NYS: CLF) and mining giant Freeport-McMoRan Copper & Gold (NYS: FCX) have seen double-digit percentage declines so far this year as demand for industrial metals like copper and steel has fallen off sharply.

Earnings for the materials sector are expected to drop almost 12% in the second quarter from last year's levels. That should increase levels of caution among investors, as even attractive P/E ratios won't take into account falling earnings. Once a rebound in global economic activity takes hold, these stocks could rise significantly -- but such a rebound could take a long time to materialize.

Utility stocks performed very well in 2011, as falling natural-gas prices helped reduce their costs and bolster profitability. But as gas hit bottom, utilities finally reached the limit of their gains from moving electrical generation from coal to gas. As a result, some utility stocks, such as Exelon (NYS: EXC) , have given up a lot of ground so far in 2012, while most others have failed to move much at all.

Going forward, a slowing economy threatens electricity demand, which helps explain why analysts expect utility earnings to drop by more than 8% in the second quarter. A return to stronger growth could reverse that trend, but if the economy falls back into recession, then it could spell trouble for utilities going forward.

Energy and telecom
The two other sectors expected to see earnings declines of 5% or more are energy and telecom. But shares have moved in much different directions between the two groups. Telecom stocks have largely risen, even in the face of an earnings slowdown, as giants AT&T and Verizon are taking steps to try to boost their long-term net income by cutting back on subsidy payments and encouraging products that allow them to keep more revenue for themselves.

Energy stocks, on the other hand, have already fallen sharply. With oil prices diving into the low $80s, nearly every major stock in the sector has suffered losses for the year, with many smaller companies seeing double-digit percentage declines. Chesapeake Energy (NYS: CHK) is an extreme case due to its internal strife, but falling natural-gas prices took their toll on producers, and from smaller player Cabot Oil & Gas (NYS: COG) to larger companies like Marathon Oil, shares are already pricing in a huge slowdown.

Expectations are everything in these two sectors. With a general sense of optimism, telecoms could suffer from the slightest bit of bad news. In energy, though, the gloomy outlook potentially provides more upside potential if things turn out to be better than the worst-case scenario.

Keep paying attention
Every quarter's earnings season has a slightly different flavor, and the second quarter will force investors to wrestle with something they haven't had to deal with for a while: slowing growth. How they respond to losing that growth dynamic could be a big determinant of how the stock market performs this summer and beyond.

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At the time thisarticle was published Fool contributor Dan Caplinger is ready for the market to plunge. He doesn't own shares of the companies mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool owns shares of Chesapeake Energy and Freeport-McMoRan Copper & Gold. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy and Exelon, as well as writing a covered straddle position in Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is like a bungee cord for your money.

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