The first out of the gate was Lehman Brothers and it was ugly, then Goldman Sachs (GS) and Morgan Stanley (MS) came out with far better than expected numbers, although they were of absolutely terrible quality. A huge part of Morgan Stanley?s gains came from the fact that their bonds (not their holds, but the actual bonds they had issued) were trading at a very deep discount. All fell sharply on the news, and for Lehman the fall was permanent. Lehman?s results are no longer included in the S&P 500, and thus the numbers that you see significantly understate the downside.

We are not that sure how much of the Financial sector will be included in the results at this point. Huge players as of a year ago effectively no longer exist as far as the public market is concerned. Lehman, Fannie, Freddie and AIG no longer exist. Merrill Lynch (MER) is being merged out of existence. However, there was not much time for analysts to make changes in their earnings estimates before news came of the mind boggling huge government bailout.

To date, 12 of the 500 firms in the S&P 500 have reported. The median year-over-year growth rate currently stands -2.8%. The median surprise stands at +3.7% and positive surprises lead disappointments by seven to four.

More important than the reported results so far are the expectations for the 488 firms that have not yet reported. The median expected year-over-year growth rate for those firms is a gain of 6.6%, which, given the historical propensity of more firms to report positive surprises than disappointments, leaves oven the possibility of double-digit median EPS gains.

Energy is expected to have the best results by a wide margin, with a gain of 33.3%, with Technology in second way back at 11.8%. Health Care and Industrials are close on the heels of Tech at 11.0% and 10.4% respectively.

Not surprisingly Financials are expected to post the worst performance with a 11.4% decline. The bailout plan, if enacted, will dramatically change the fortunes of the Financial sector going forward. Giving away hundreds of billions of taxpayer dollars will do that. Make no mistake, as currently envisioned that is exactly what we are talking about with the Treasury plan.

Keep in mind that median growth rates are inherently equally weighted, so the growth rate for Cabot Oil and Gas (COG) is just as significant to the results for the Energy sector as the growth rate for Exxon (XOM).

Share repurchases were still very significant in the fourth quarter of last year and during the first quarter of this year. (The data is not out yet for the second quarter.) This reduction in share count boosts EPS growth.

Currency translation gains will be less of a factor this quarter due to the rebound in the dollar. However, the strong overseas demand that the previously very weak dollar stimulated will still prove to be a boost to the third-quarter earnings of many firms. (A lag exists between the date an order was placed and a shipment has been made.) Given both the rebound in the dollar and the very significant economic slowdown abroad, look for the export boom to fade in the fourth quarter and into 2009.

Total Net Income Growth

On a total net income basis, the results reported so far look far worse than on a Median EPS growth basis. Total earnings for the dozen firms that have reported are down 23.4% largely due to a 47.1% plunge in the Financials. While it is a very small sample, it is worth noting that this is a much weaker performance than those same twelve firms reported in the second quarter.

Looking ahead to those yet to report, the expected decline for the S&P 500 as a whole deteriorated to a decline of 4.7% from a 3.0% decline last week. That is still a dramatic improvement over what we saw in any of the previous three quarters.

The expected decline in the Financial sector deteriorated to a 59.5% decline from 49.8% last week. The Consumer Discretionary sector is also expected to be extremely weak with a 28.1% decline. I would contend that the Financials? estimates are no longer operative, and it seems highly unlikely that the sector as a whole will be in the black this quarter.

The only sector with truly robust growth in total net income for the quarter is expected to be Energy, where the forecast is for a gain of 49.6%. Materials is a distant second with expected growth of 12.0%. All other sectors are expected to post anemic growth at best.

The early expectations for the fourth quarter are for a huge rebound in earnings with the total S&P 500 net income popping 35.0% due to a swing from losses to profits in the Financial sector (hence shown in the table as a negative number of over 100%, when in that territory the percentage gain numbers just get plain goofy, so don?t get hung up on the exact number there). Given recent events, and the current Treasury plan, it is probably almost impossible to get an accurate read on what the earnings for the sector will look like.

Under the plan, the government will be buying up the bad investments held by banks and investment banks. If the government buys at the prices this paper is currently trading for (to the extent it does trade), then it will do nothing to really solve the problem. The banks will recognize their losses which will deplete their capital, and they will report truly horrific losses. However, to the extent that it buys up the paper at above market prices, it is nothing less that a pure give away to the sector. Also the timing of these purchases is very much up in the air. One would assume that very few if any would be made in the third quarter, with the volume of purchases growing over the fourth quarter and into 2009.

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. With smaller totals for any given sector than the S&P 500 over all, the ratio should be farther away from 1.0 to be truly significant. However, for the sake of consistency, we refer to readings above 1.25 as being in positive territory and below 0.80 as being in negative territory.

The effect of second-quarter surprises has almost totally worn off, and with it the boost we saw to the revisions ratio. With the total number of revisions now falling, so is the ratio of increases to cuts. The ratio continued its dramatic drop into negative territory this week. It is now at 0.48, a reading that is still neutral, but down from 0.56 last week and 0.84 two weeks ago. This means that for the S&P 500 as a whole, there were almost twice as many estimate cuts as there were increases. That is one ugly number, the only real consolation in it is that we are in the slow season for revisions overall.

Over the last 4 weeks there have been 1,023 changes in estimates (331 up and 692 down), a decrease of 8.0% from 1,112 revisions last week (399 up and 713 down). We are probably close to the seasonal bottom in total estimate revisions. The ratio of firms with rising mean estimates to falling mean estimates is 0.62, stronger than the revisions ratio, but also deep in negative territory.

No sector was in positive territory this week. That has not happened in a very long time, although the Consumer Durables sector still above the 1.0 level. Financials and Utilities are battling for the title of the worst, with revisions ratios of 0.18 and 0.25 respectively. However, the utility number is based on a very small sample of just 25 total estimates so the reading is much less significant that the Financial sector reading that is based on a total of 183 estimates. Energy, Tech and Telecom were all deep in negative territory as well.

The revisions ratio for 2009 is just as weak as for 2008. It fell deeper into negative territory with a reading of 0.49, down from 0.51 last week, and 0.71 two weeks ago. These sorts of cuts will start to dig into the robust rebound in profitability that is currently expected for 2009 (up 25.8% on a total earnings basis, and 10.7% on a median EPS growth basis). The strong net income number is almost entirely a function of the Financials not continuing to implode in 2009.

Only three sectors barely make it into in neutral territory, Consumer Discretionary, Industrials and Materials. All other sectors are deep in negative territory, most notably the Financials where estimate cuts outnumber increases by better than four to one.

The total number of revisions for the whole S&P 500 for 2009 is also continuing it seasonal plunge. There were a total of 969 revisions: 318 up and 651 down. This is down 5.2% from 1,022 (347 up and 675 down) last week. The ratio of firms with rising mean estimates to falling mean estimates is 0.51, identical to the revisions ratio.

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 decisively dethroned on both counts. On the Market cap front it is in second place. However, it has now slipped into sixth place based on 2008 earnings. Still, despite their current problems, the Financials are still a very significant influence on the market.

Even with all the disasters in the sector, for 2007, the Financials accounted for 21.8% of the total net income for the S&P 500. In 2008, that is currently expected to decline to 9.1% before rebounding to 16.9% in 2009. However, in recent years the sector has normally accounted for well over a quarter of all earnings.

Energy has usurped the crown this year, with its earnings share climbing to 22.0% from 15.6% in 2007. Energy should keep the earnings crown for 2009 as well, gathering 19.7% of all the earnings of the S&P 500.

On the market cap (and index weight) front, Tech overtook the Financials a few months ago and currently stands at 16.1%. The Financials have since rebounded significantly and are virtually tied with Tech for the biggest weight in index also at 16.1%. (Tech still leads if you vary out beyond on decimal point). Energy has the 3rd highest weighting at 13.1%. There is thus a huge disparity between the market share weights and the earnings weights for the Financial and Energy sectors, with Energy being extraordinarily cheap and the Financials extremely expensive.

Keep in mind that these numbers are snapshots, when you should be thinking about a movie. At the end of February (the first time we had a complete read on 2009), the Financials were expected to gather 22.1% 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. A year ago before the credit crunch hit, Financials were expected to gather 26.3% of 2008 earnings and held a 19.4% weighting in the index. Energy represented just 10.9% of the total market capitalization and was expected to get 12.9% of the total earnings in 2008.

For many years Financials were clearly the dominate factor in the overall market, despite generally selling for below market P/Es. Due to an implosion in earnings that has been far worse than the dismal market performance of the sector, the Financials now has the highest P/E based on 2008 earnings, displacing the perennial high P/E sector Technology. Based on 2008 earnings, the Financials have a P/E of 26.4x. However, given the expectation that the bleeding will stop next year, the P/E based on 2009 earnings is just 11.4x. The true P/E is probably higher since negative estimate revisions suggest the actual earnings will be significantly lower.

Energy has just taken the throne as the cheapest based on 2008 earnings trading at 8.9x, and 8.0x based on 2009 expectations. There is no question in my mind that Energy is the cheapest sector of the market, and every portfolio should be overweight in it. The Tech sector has a somewhat higher than market P/E, trading for 16.4x 2008 and 14.0 x 2009 expectations. The premium to the market is, however, lower than it has been in some time and the sector is starting to look interesting. Health Care also looks interesting trading at 13.9x 2008 and 12.6x 2009 earnings.

Keep your eyes on the revisions, they give you the best clue as to if the earnings will be achieved and if the P/Es are for real. While the recent declines in oil prices may cause the upwards revisions to moderate for the Energy sector, most analysts are using very conservative price assumptions.

The S&P 500 as a whole is trading for 15.0x and 12.0x, 2008 and 2009 earnings, respectively. Based on a blend of 33% 2008 earnings and 67% 2009 earnings; that translates to a 7.71% earnings yield, which looks extremely cheap relative to a 3.80% ten year T-note. Even against the A-rated corporate bond yield of 6.30% 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. (There are attractive stocks out there, however.) It appears that the flight to quality has caused a massive bubble in the price of T-notes. This is far and away, in my opinion, the most significant bubble in the market today, not the price of oil. 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 9/18/2008