The Most Attractive Sector in the S&P 500?
By Chris Puplava, August 19, 2009
With the S&P 500 up more roughly 50% from the March lows and sporting a price-to-earnings (P/E) ratio of 18.37, the market is clearly no longer cheap as the low hanging fruit has been plucked by Mr. Market. However, while the overall market may no longer be cheap there are plenty of pockets of value as many industries have been overlooked and under bought in the run up since March, and based on historical valuations, relative performance, and relative valuation, the industrial sector is perhaps the most attractive sector in the S&P 500 currently.
In 2009 the hot sectors have clearly been the beta plays that are the typical favorites after a recession and steep market correction, those being the materials, technology, and consumer discretionary sectors. These three sectors are up high double-digits year-to-date (YTD), with the technology sector coming in at first place (+34.39%) followed by the materials sector (+26.67%) and the consumer discretionary sector (+17.98%) taking the bronze. So far the run up in the aforementioned sectors has not been entirely driven by fundamentals, such as earnings and sales, as an expansion in their price multiples has played a significant factor with all three sectors presenting the highest P/E ratios of the S&P 500. The YTD performance numbers and P/E ratios for the S&P 500 sectors are shown below.
S&P Sectors: From High Best to Worst YTD Performance
Source: Bloomberg
S&P Sectors: From High to Low P/E Ratio
Source: Bloomberg
As seen in the tables above, the industrial sector is roughly in the middle of the pack with a P/E ratio of 12.31 and a YTD performance of 1.57%. While the sector may be in the middle of the pack in terms of current P/E multiple and performance, it is the most attractive sector when comparing the average of its historical valuation levels and relative performance and relative valuation levels. Screening all S&P 500 sectors did show some sectors that were at more attractive levels than the industrials on one of the three metrics listed above, but they were not attractive on one ore more of the other two metrics. Only the industrial sector was attractive on all three metrics.
Looking at the twelve month relative performance for the industrial sector shows that it is currently at 1.4 standard deviations below its historical average and its smoothed relative performance appears to be putting in a bottom as the sector may begin to outperform the broad market ahead.
Source: Bloomberg
In terms of the sector’s historical valuation (only a relatively short data set was available), the sector is the cheapest it has been in nearly 15 years as its composite valuation is nearly two standard deviations below its mean after reaching 3.7 standard deviations below its mean in March. In terms of relative valuation to the S&P 500, the sector reached nearly 3 standard deviations below its mean at the March Lows and is presently 2.23 standard deviations below its historical average. When looking at the two charts below, you can see that the sector is cheap on a historical valuation level as well as a relative valuation level.
Source: Bloomberg
Source: Bloomberg
Again, what makes the industrial sector attractive currently is that it is oversold on a relative valuation and relative performance perspective, and its own historical valuations are currently cheap. The three industries that make up the industrial sector are capital goods, commercial & professional services, and the transportation industry. Of the three industries the capital goods industry appears the most attractive from a valuation and performance perspective.
In terms of relative performance, the industry is roughly two standard deviations below its average as it has underperformed the S&P 500 by roughly 13% over the last twelve months, and is currently at a level that has marked the beginning of a period of outperformance.
Source: Bloomberg
Looking at the industry’s valuations shows that the sector is the cheapest it has been in the last 15 years as valuations reached 3.5 standard deviations from its historical average at the March lows, with the industry still roughly 2 standard deviations below its historical average. Not only is the sector undervalued compared to its historical valuations, it is also the most undervalued it has been relative to the S&P 500 since 1993.
Source: Bloomberg
Source: Bloomberg
Overall, the S&P Capital Goods sector appears to be incredibly attractive as all the stars appear in alignment. The industry’s valuation’s are at 13 year lows and both its relative value and relative performance measures are also at 13 year lows as seen below. For this reason it appears research into the capital goods industry may be well rewarded in the months ahead as the industry appears under owned and under watched by investors, with a fundamental table given below for the industry.
Source: Bloomberg
Source: Bloomberg
Chris Puplava
© 2009 Chris Puplava
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Christopher M. Puplava
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