Since the beginning of the year, the main US S&P 500 index has risen by more than 13%, almost reaching its historic peaks. What has driven the market in recent years and which sectors are historically considered the most undervalued?
Is the market currently overvalued?
For a historical comparison of valuations, we will use the basic ratio of price to next year's (forecast) net profit (forward P/E). Before doing so, however, we will point out the most important disadvantage of this parameter. It is based on past earnings, whereas the market share price includes a forecast for the following months. Of course, it is important to bear in mind here that the use of earnings forecasts is subject to a certain degree of risk, and forecasts will differ from one another. Nevertheless, the use of forecasts brings us much closer to reality than the analysis of historical data alone.
Source: https://www.multpl.com/s-p-500-pe-ratio
Currently, the fundamental P/E ratio for the S&P 500 index is 24.8. In the more than 100-year history of the US stock market, it has only been 8% higher. However, if we look at the values of this ratio since the beginning of 2000, it has been higher in 36% of the years. Does this mean that we are currently in a period of overvaluation in the market?
Source: Conotoxia own analysis
Source: Conotoxia own analysis
However, if earnings forecasts are taken into account, it becomes clear that the S&P 500 index is far from being in an overvalued state. The current value of the future price-to-earnings (P/E) ratio is 23, according to Gurufocus data, and the forecast for the end of 2024 is for it to fall to 19.1 at current index levels, which is practically in the middle of the median range of 18. In summary, we can conclude that we are currently a long way from crises such as the technology bubble (2000), the financial crisis (2008) or even post-pandemic crisis levels (2020). However, the high current values of the P/E ratio reflect the low level of profits that are the result of the economic downturn.
Source: https://www.gurufocus.com/economic_indicators/6061/sp-500-pe-ratio-with-forward-estimate
Sectors mostly able to enjoy good results
If we look at the sectors' rates of return in a year-on-year comparison, there is a clear dominance of two sectors: technology and communication services, which reached 24.1 and 22% respectively. This is largely due to the potential for the development of artificial intelligence (AI), with Nvidia or Cosco.
The worst-performing sectors were real estate and utilities, which recorded declines of 10.8% and 13.5% respectively. For the real estate sector in particular, this decline is not necessarily surprising, as this market is particularly sensitive to high interest rate levels.
Source: https://finviz.com/groups.ashx
Sectors most sensitive to cycles are not cheap
The consumer goods (Consumer Discretionary) and technology (Information Technology) sectors are mainly exposed to economic cycles. Their future P/E ratios currently stand at 25. Although these values are not the lowest they have been in recent years (especially when compared to the pre-crisis period in 2008), it is difficult to speak today of an imminent crisis. It is also worth noting that, comparing the current P/E ratios to the technology bubble period of 2000, when they reached as high as 45, it is difficult to consider that there is currently a bubble in the technology sector. Consequently, if artificial intelligence were to cause a similar stir to the development of the internet, we could expect to see a continuation of increases, including on the Nasdaq index (US100).
Source: https://www.yardeni.com/
Source: Conotoxia MT5, US100, Daily
Does safe equals cheap?
The least susceptible to economic cycles are the basic goods (Consumer Staples), health care and finance sectors. These appear relatively stable regardless of the economic climate, as there is a constant need to purchase basic products, health care and use financial services.
However, when we look at their valuations in a historical context, we can see that the basic goods sector remains at a higher level, but not above the norm (forward P/E ratio is 19.1). The health sector is a long way from the levels of 2000 (forward P/E ratio is 17.2) and the financial sector remains at its natural level, despite the banking crisis earlier this year (the forward P/E ratio is 13.5), and is a long way from the state before the 2008 financial crisis.
Source: https://www.yardeni.com/
The combination of high growth potential and historically low valuations may benefit the performance of the Health Care Select Sector SPDR Fund (XLV).
Source: Conotoxia MT5, XLV, Daily
The Communication Services and Utilities sectors are also hardly overvalued. The price-to-future earnings ratio (forward P/E) is currently 16.8 for Communication Services and 16.2 for Utilities. However, like the healthcare sector, the utilities sector has much more upside potential as it is below the levels of the last three downturns. This could benefit the listing of the Communication Services Select Sector SPDR Fund (XLC).
Source: https://www.yardeni.com/
Grzegorz Dróżdż, CAI MPW, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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