In the past, we’ve spent time in this space looking at overall index valuation levels for country level indices around the world. After looking at US GDP aggregates last week, it occurred to us that looking at long-term P/E ratios by sector for both the S&P 500 and the MSCI World may give us additional insight into where the markets have been and where they might pivot in coming years.
As with past valuation exercises, we prefer to use normalized 10-year trailing P/E ratios to eliminate much of the short-term noise in the data associated with short-term earnings cycles. This has been particularly important in recent years considering the high level of earnings volatility that’s been observed at various points over the past decade. Our sector level earnings data comes from Bloomberg. In the case of the S&P 500 sectors, data in Bloomberg goes back to 1991, allowing us to construct ratios from 2001 forward. For the MSCI World, sector data goes back to 1995 allowing us to begin in 2005.
First, let’s look at valuation in table form:
S&P 500 Sector P/E Ratios
|
Overall S&P 500
|
22.8
|
|
Consumer Discretionary
|
34.5
|
|
Information Technology
|
27.9
|
|
Consumer Staples
|
26.7
|
|
Health Care
|
24.6
|
|
Industrials
|
24.1
|
|
Materials
|
22.5
|
|
Telecom Services
|
20.4
|
|
Utilities
|
17.4
|
|
Energy
|
17.0
|
|
Financials
|
14.7
|
*Bold Italics: above trailing 10-year avg. P/E
MSCI World Sector P/E Ratios
|
Overall MSCI World
|
21.0
|
|
Consumer Discretionary
|
30.8
|
|
Information Technology
|
28.1
|
|
Consumer Staples
|
26.9
|
|
Health Care
|
25.3
|
|
Industrials
|
23.4
|
|
Telecom Services
|
21.2
|
|
Materials
|
18.5
|
|
Utilities
|
16.0
|
|
Energy
|
14.7
|
|
Financials
|
13.4
|
*Bold Italics: above average P/E since 2005 (bgn of data)
Last week when looking at the expenditure components of GDP, we noted that the high level of consumer spending relative to historical averages might bode poorly for the consumer related market sectors’ future performance. Looking at valuation levels above, we see that Consumer Discretionary is trading comfortably above 30x in the S&P 500 and above 30x in the overall MSCI World index as well. The Consumer Staples sector isn’t far behind either, coming in as the third highest valuation sector in both indices. Granted, the data series we have access doesn’t go back terribly far, but Consumer Discretionary is trading nearly two standard deviations above the average valuation of the past decade.
On the flip side, the Financials and Energy sectors hold the bottom spots in both the S&P 500 and the MSCI World and remain well below the overall averages for the index. Financial sector stocks remain far below the former peaks. The Financial sector indices were obliterated during the financial crisis. Valuations fell below 5x in the S&P 500 and just above 5x in the MSCI World. While the energy sector indices are moving closer to all-time highs, valuations remain compressed because normalized earnings have been able to keep pace with stock prices.
The Information Technology sector is very interesting. In the MSCI World and S&P 500, IT holds the 2nd spot in terms of highest valuation even though prices for the sector indices remain far below the peaks achieved in the early 2000s. The tech sector in the S&P 500 remains 43% below the peak price level from the early 2000s! At the beginning of the data series (the last gasps of the tech boom), IT was trading over 100x normalized earnings in the S&P 500! Even with the collapse in price and strong growth in the normalized earnings figure over the past decade, valuations remain close to 30x. A decade later, IT is still working off the massively excessive valuations. IT shows the perils of investing in stocks priced to infinity and beyond!
Health care is another sector that bears watching. Valuation is closer to the top of the current tables. Yet, like IT, Health Care traded at nosebleed valuations a decade or so ago meaning that the 12-year chart of Health Care P/Es shows compression over time. Health Care companies have obviously benefitted from the aging of developed world populations, development of new health care technologies, and other factors. Future demographics are very favorable as well. It appears much of this optimism remains priced in, however. In the both the S&P 500 and MSCI World, the Health Care sub-index prices are approximately 50% above levels observed before the economic crisis. It may be a much tougher row to hoe from here on out; multiples could resume their march down and to the right of the valuation charts.
Wrapping up, the consumer sectors appear especially overvalued and the probability remains high for subpar equity performance out of these sectors in coming years. Info Tech has worked off significant excess over the past twelve years, but remains vulnerable to multiple compressions. Health Care is another sector that appears vulnerable over the next several years. Alternately, financials and energy multiples remain far below broader index multiples and the multiples for other sectors, suggesting they may carry the water for the broader indices in coming years.
Below, we’ve included all of the charts for the individual sector P/E ratios.
World Sector P/E Charts:
S&P 500 Sector P/E Charts:
