I recently argued that the near-peak profit margins of U.S. companies would fall over the next several quarters, resulting in negative earnings surprises and putting pressure on stock prices. It's possible this process began in the second quarter, during which sentiment soured, unemployment remained stubbornly high, and the recovery in housing flagged. In that context, which sectors are well-protected and which are vulnerable?
I've made no secret about favoring defensive sectors in this environment, and health care and consumer staples provide some buffers going into this earnings season. Their second-quarter earnings estimates have already begun to come down since the end of March and health care is the cheapest sector in the S&P 500 (11.3 times its 2010 earnings per share estimate).
The Consumer Staples Select SPDR ETF
Cyclical is suspect
On the other hand, industrials and financials look particularly vulnerable to disappointments because they're cyclical and they're two of the three sectors that have experienced the highest increase in their second-quarter EPS estimates since the end of March. Worse, for industrials, it's the most expensive sector on the basis of its price-to-earnings multiple (14.8 times its 2010 EPS estimate against 13.1 for the S&P 500).
Less than 5% of the S&P 500 will report earnings next week, but that number includes cyclical bellwethers Bank of America
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Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.