These Are the 3 Hottest Sectors for Q3 Earnings Growth

Key Points

• The forecasts for Q3 earnings are on the rise, suggesting a strong quarter to lift market spirits.
• AI is a central theme that impacts the outlook for sectors beyond technology.
• The risk is that the S&P 500 and underlying sector indices reveal some weakness that could result in a pullback and buying opportunity before the year's end. 

The onset of Q3 earnings season is just around the corner, and it looks like it will be a good one. Not only is there an outlook for S&P 500 NYSEARCA: SPY earnings growth and sequential acceleration to follow, but the forecasts are also improving, providing a lift for market spirits.

As of early October, the consensus for the year is for earnings to grow by 8.0%, an 80-basis-point improvement from the lows of the revision cycle, and the forecast for the following year is also improving. 

Three sectors are setting the pace for Q3 earnings growth—and could drive index gains into Q4. Tech, energy, and financials are leading the charge, supported by strong forecasts and key macro tailwinds. But with expectations running high, even solid results could trigger volatility. In a market priced for strength, the risk of a pullback on "good enough" earnings remains.

The AI Trade Continues to Gain Momentum

The revision trends reveal that the AI trade is alive and well and gaining momentum in the fourth quarter. The consensus figure for the Technology Sector’s NYSEARCA: XLK earnings growth is not only the most robust at up 21%, but the revisions are also the hottest. The consensus is up approximately 550 basis points since the cycle low and is likely to continue higher. 

The primary driver is NVIDIA NASDAQ: NVDA, which has seen 95% of its analysts increase their earnings estimates over the preceding 90 days, and is expected to grow its earnings by another 50% or more. Also driving the technology sector outlook are Microsoft NASDAQ: MSFT, Apple NASDAQ: AAPL, Broadcom NASDAQ: AVGO, and Oracle NYSE: ORCL, whose analysts are also lifting earnings estimates. Collectively, including NVIDIA, they represent 50% of the Information Technology Sector and a comparably large portion of the S&P 500. 

The XLK index is trending higher ahead of the peak reporting season and is likely to continue advancing as the year progresses. However, investors may exercise caution due to the advanced nature of the rally. The market has increased by more than 55% since the last major correction, so it could pull back at any time. Additionally, divergence in the MACD indicates that the rally has weakened, setting the stock price up for potential profit-taking and consolidation that could begin soon, regardless of the strength of Q3 earnings.

Utilities: AI Is Electrifying Growth 

AI companies are increasing their power consumption daily, driving global electricity demand. At the same time, EV demand is growing, and utilities are investing in modernization and infrastructure to support it. The key takeaway is that the rate base is growing for this sector while rates are increasing, providing a lever for growth. 

The impact on the earnings outlook is that the Utilities Sector NYSEARCA: XLU is forecast to post the second-strongest growth this reporting cycle, and estimates are rising. Up more than 225 basis points since the start of Q3, the consensus figure for the Utilities sector is +18%, led by companies including Constellation Energy NASDAQ: CEG. It is forecast to grow its earnings by more than 15% with nearly 60% of its analysts having lifted their target during the reporting period. 

The Utilities Sector ETF is also trending higher, having reached new highs in early October. The move is likely to continue, driven by earnings strength and capital returns; however, investors should remain cautious. Technical conditions, including a diverging MACD and an overbought stochastic, suggest that this market could pull back at any time.

Dual Tailwinds for Financial Stocks

The Financial Sector NYSEARCA: XLF is forecasted to have grown by 11.5% in Q3, driven by lingering NII strength tied to higher interest rates and consumer resiliency. The forecasts for this sector are also rising, with the consensus up by 400 basis points from its low at the start of the period. 

The leading stocks in this group include Berkshire Hathaway NYSE: BRK.A and JPMorgan NYSE: JPM, which are well-suited to benefit from the application of AI. On the one hand, Berkshire is a massive insurance company that utilizes AI analysis and automation throughout its network. On the other hand, JPMorgan is the world’s largest financial institution outside of China, and it is planning to become the first fully AI-assisted bank globally. 

The XLF ETF is also trending higher, poised to make a move that the upcoming earnings reports are expected to catalyze. The likely outcome is a move higher, but once again, this market exhibits some signs of weakening that could result in a price correction or extended consolidation if the results fail to impress the market.