The S&P 500 Index (SPX) has staged an impressive rebound in recent weeks, but it still trades more than 10% below its 52-week high. That may make the market still ripe for bargain-hunting by investors. "Following the sell-off, stocks now look inexpensive or close to fair value versus history on most metrics, excepting a few backward-looking metrics," according to Bank of America Merrill Lynch.
In particular, BofAML notes that the forward P/E ratio for the S&P 500 is now at its lowest level in more than five years. Additionally, their report finds that five sectors within the broader index have especially attractive valuations right now, based on comparisons of current to average historical price-to-book (P/B) ratios (see below).
5 Cheap Sectors
- Energy: 65%
- Financials: 38%
- Health Care: 28%
- Materials: 23%
- Consumer Staples: 14%
Source: Bank of America Merrill Lynch
Significance For Investors
In their analysis, BofAML looked at three valuation metrics: forward P/E ratio, price-to-book (P/B) ratio, and price to operating cash flow ratio. They then compared current valuations to the historical averages from 1986 through the end of 2018. The implied upsides for the five sectors listed above reflect how much their current price to book ratios have to rise to reach their historical averages.
Energy also has implied upsides of 15% based on forward P/E and 26% based on price to cash flow. For health care, the respective upsides are 8% and 23%. The picture for financials, materials, and consumer is a bit more complex, with a mix of modest discounts and premiums implied by these two additional valuation metrics.
Based on "positive EPS revisions and attractive valuations," financial stocks now rank second in BofAML's "tactical quant sector framework." Utilities rank first, despite showing only 5% upside based on P/B, while also having 21% downside when forward P/E is considered.
Meanwhile, although information technology "still has characteristics that appear to be attractive in the long-term and we are overweight the sector over a 12-month time horizon, our tactical model flags potential near-term risks," the report warns. In particular, hardware storage & peripherals, of which Apple Inc. (AAPL) represents 88%, and semiconductors are industry groups that BAML indicates still have downside. They are "falling faster than earnings cuts," the firm notes.
At a more macro level, the forward P/E ratio for the entire S&P 500 fell by 21% in 2018, to end the year at 14.1 times projected next 12 months earnings. It subsequently rebounded to 15.1 times as of the close on Jan. 15, 2019, but, apart from the recent low set in December, this is still lower than at any other time between Sept. 2013 and now, BofAML adds.
Whether the five sectors listed above really are cheap enough now to be really attractive at this point is a matter for debate. Several indicators suggest that the next recession is fast approaching, Morgan Stanley finds, and the anticipation of an economic contraction is bound to induce another downdraft in stock prices.