Market volatility has been blamed on a number of factors this year – the Chinese market meltdown, weakness in the oil patch and the never-ending speculation around when (or if) the Fed will ever raise rates being chief among them.
But there is one underappreciated reason for the market’s lack of direction this year, and that’s valuation.
There’s really no way to massage these numbers. Stocks are expensive by virtually any metric you care to choose. Back in September, I highlighted the cyclically-adjusted price/earnings ratio (CAPE), which smooths out the fluctuations of the business cycle by taking a 10-year average of earnings.
Well, based on that metric… stocks are priced to deliver returns of a rather pitiful 0.5% per year over the next eight years.
Don’t spend all of that in one place!
While the overall market is expensive, there are potential pockets of value out there. Using data from research site GuruFocus, I parsed the market into 10 sectors and compared their current CAPE valuation to the high and low values of the past six years.
I consider any sector trading near the bottom of the range to be at least relatively cheap, while any sector trading near the top end of the range would be expensive.
So, how does it look?
As you can see, we have a really mixed bag.
With a CAPE of 31.0, Communication Services is the most expensive sector, though it’s a fair bit cheaper than the 36.8 we saw in July of 2013. All the same, I would expect it to get a lot cheaper. Most of the stocks in this sector are cable TV and phone operators – two subsectors with very limited growth prospects in America.
Healthcare, with a CAPE of 30.2, isn’t far behind. And it’s not far at all from its all-time highs. Adam has been warning his Cycle 9 Alert readers to steer clear of this sector, and I agree.
Yes, the sector is backed by strong demographics, but investors are simply paying too high a price for that growth.
The cheapest sector by a wide margin is energy, trading at a CAPE of 12.2. That’s scraping near its lows of the past six years. Of course, the energy sector is also getting roiled by the crude oil supply glut, and this sector is not without its risks.
Perhaps the most interesting sector right now is consumer cyclicals. At a current CAPE of 28.8, it might not seem particularly cheap. But remember, this sector was trading at a CAPE of 55.4 in late 2010, and the lowest it’s been over the past six years is 25.2.
This is a broad sector that contains everything from automakers to bath towel retailers, so you’d want to pick and choose carefully. But in an otherwise expensive market, you might find some real gems.
Editor, Dent 401k Advisor