There are only a relative handful of actual earnings reports in, and those do not seem that encouraging, although on balance they are still beating expectations. There is considerable uncertainty about third-quarter earnings and the very slow pace of estimate revisions does not give us that much to go on.

We are not even 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, WAMU and AIG effectively longer exist as public companies. Bear Sterns, Wachovia and Merrill Lynch are being merged out of existence. There is constant speculation about who will be next, and make no mistake, there will be more.

More important than the reported results so far are the expectations for the 476 firms that have not yet reported. The median expected year-over-year growth rate for those firms is a gain of 9.76%. Given given the historical propensity of more firms to report positive surprises than disappointments, there is a the possibility of double-digit median EPS gains.

Energy is expected to have the best results with a gain of 25.9%, with Technology in second at 20.9%. Health Care and Industrials are in a tight battle for the bronze spot at 15.6% and 15.4% respectively.

Not surprisingly Financials are expected to post the worst performance with a 17.4% decline. This number seems optimistic to me across the board given the current environment. However, it may reflect somewhat better economic conditions in July and August than we face today. Looking ahead to the fourth quarter, the Financials face extremely easy comparisons, but given the magnitude of the current problems, even that might not be enough to make them look good. (Although, based on current expectations they Financial earnings will look good, but estimate revisions activity is still sluggish).

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 the first quarter of this year (the data is not out yet for the second quarter) and the reduction in share count also 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 earnings of many firms. The delay is because in the third quarter they will be shipping goods ordered previously. 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 24 firms that have reported are down 25.1% largely due to a 45.2% 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 8.1% from a 6.2% decline last week, and 4.7% two weeks ago. That is still a dramatic improvement over what we saw in any of the previous three quarters. Note that the figures shown are for the S&P 500 as currently constituted, not the S&P 500 as constituted at the time the previous quarters were reported. The reported declines were much worse.

The expected decline in the Financial sector deteriorated to a 67.9% decline from 61.4% last week and 59.5% two weeks ago. Personally I will be shocked if when all is said and done the decline is less than 100% for the sector. 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 Consumer Discretionary sector is also expected to be extremely weak with a 20.3% decline.

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 46.7%. Given the decline in the price for both oil and natural gas in September, those estimates are also probably optimistic.

Consumer Staples is a distant second with expected growth of 5.6%. 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 28.9% 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 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 the 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 total number of revisions is low, so is the ratio of increases to cuts. The ratio continued its dramatic drop into negative territory this week. It is now at 0.32, a reading that is deep in negative territory, down from 0.40 last week and 0.48 two weeks ago. In other words, across the entire S&P 500, there are more than three estimate cuts for 2008 earnings for every increase.

This is the lowest level for the revisions ratio in the three years I have been writing Earnings Trends. As the effects of the credit crunch continue to filter through the economy, look for this number to continue to decline. The only real consolation in it is that we are in the slow season for revisions overall, although the number is starting to rise, which is somewhat unusual for this point in the normal quarterly earnings cycle.

At the margin, all the estimate changes have been to the downside. Over the last four weeks there have been 1,295 changes in estimates (311 up and 984 down), up 15% from 1,125 last week (320 up and 805 down). Look for the total number of revisions to more than triple over the next 6 weeks.

The ratio of firms with rising mean estimates to falling mean estimates is 0.43, stronger than the revisions ratio, but also deep in negative territory.

No sector was in positive territory this week. Industrials were the best of a bad bunch with a reading of 0.68. Financials and Telecom are battling for the title of the worst, with revisions ratios of 0.15 and 0.17 respectively. However, the Telecom number is based on a very small sample of just 14 total estimates so the reading is much less significant that the Financial sector reading that is based on a total of 252 estimates. Energy, Tech and Materials were all deep in negative territory as well, with more than 4 cuts for every increase.

The revisions ratio for 2009 is even weaker than for 2008.

It fell deeper into negative territory with a reading of 0.28, down from 0.37 last week, and 0.49 two weeks ago. These sorts of cuts will start to dig into the robust rebound in profitability that is currently expected for 2009 (up 24.5% on a total earnings basis, and 9.8% on a median EPS growth basis). However, if the numbers for 2008 plunge faster than for 2009, then the growth number will go up. The strong net income number is almost entirely a function of the Financials not continuing to implode in 2009 (or at least imploding less than in 2008, total earnings will still be 26.4% below 2007 levels for the sector).

No sector even comes close to making it into neutral territory. The best of the worst was Consumer Staples with a reading of 0.47. In every other sector there were more than two cuts for every increase. The ugliest of ugly was the Financials where there were over seven cuts for each increase.

The total number of revisions for the whole S&P 500 for 2009 is also starting to rise, and sooner than one would expect from the normal seasonal pattern. Or to be more specific, the number of cuts is rising while the number of increases is continuing to fall. There were a total of 1,149 revisions (250 up and 899 down). This is up 11.9% from 1,084 last week (292 up and 792 down). The ratio of firms with rising mean estimates to falling mean estimates is 0.35, a little bit stronger than the revisions ratio, but still ugly.

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.

Note that all figures are based on the current composition of the Financial sector, which has been considerably revamped over the past few weeks as the dominos continue to fall. The removal of several institutions that were expected to post large losses in the third and fourth quarters, and which did post large losses in the first half has improved the overall earnings share for the sector.

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 9.9% before rebounding to 16.4% in 2009. I suspect that is optimistic for both years. 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 21.5% from 15.5% in 2007. Energy should keep the earnings crown for 2009 as well, gathering 19.8% of all the earnings of the S&P 500. Tech is in second place for 2008 with a 14.8% share and in third place with a 14.1% share.

On the market cap (and index weight) front, Tech overtook the Financials earlier this year and currently stands at 16.0%. The Financials have a 15.9% weight in the index. Energy has only the fifth highest weighting at 12.5%. 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 have the highest P/E's based on 2008 earnings, displacing the perennial high P/E sector Technology. Based on 2008 earnings, the Financials have a P/E of 21.3x. However, given the expectation that the bleeding will stop next year, the P/E based on 2009 earnings is just 10.4x. 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 7.7x, and 6.8x 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 14.3x 2008 and 12.2 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 13.2x 2008 and 12.0x 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 13.2x and 10.8x, 2008 and 2009 earnings, respectively. Based on a blend of 33% 2008 earnings and 67% 2009 earnings that translates to a 8.62% earnings yield, which looks extremely cheap relative to a 3.47% ten year T-note. Even against the AA rated 10 year corporate bond yield of 7.22% 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 (and an insane bubble in the price of short term T-bills where rates approach zero, talk about being more interested in the return of capital rather than a return on capital). 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 10/2/2008