Two things investors can be sure about: Nothing lasts forever and the stock market always overreacts. The spiking of yields on long-term U.S. Treasury securities has been breathtaking, and it has led to remarkable declines for some sectors and possible bargains for contrarian investors who can commit for the long term.
First we will show how the sectors of the S&P 500 have performed. Then we will look at price-to-earnings valuations for the sectors and compare them to long-term averages. Then we will screen the entire index for companies trading below their long-term forward P/E valuation averages and narrow the list to companies most favored by analysts.
Here are total returns, with dividends reinvested, for the 11 sectors of the S&P 500, with broad indexes below. The sectors are sorted by ascending total returns this year through Monday.
|Sector or index||2023 return||2022 return||Return since end of 2021||1 week return||1 month return|
|DJ Industrial Average||2.5%||-6.9%||-4.5%||-1.7%||-4.0%|
|Nasdaq Composite Index COMP||28.0%||-32.5%||-13.7%||0.3%||-5.1%|
Returns for 2022 are also included, along with those since the end of 2021. Last year’s weakest sector, communications services, has been this year’s strongest performer. This sector includes Alphabet Inc. GOOGL and Meta Platforms Inc. META, which have returned 52% and 155% this year, respectively, but are still down since the end of 2021. To the right are returns for the past week and month through Monday.
On Monday, the S&P 500 Utilities sector had its worst one-day performance since 2020, with a 4.7% decline. Investors were reacting to the jump in long-term interest rates.
Here is a link to the U.S. Treasury Department’s summary of the daily yield curve across maturities for Treasury securities.
The yield on 10-year U.S. Treasury notes jumped 10 basis points in only one day to 4.69% on Monday. A month earlier the 10-year yield was only 4.27%. Also on Monday, the yield on 20-year Treasury bonds rose to 5.00% from 4.92% on Friday. It was up from 4.56% a month earlier.
The Treasury yield curve is still inverted, with 3-month T-bills yielding 5.62% on Monday, but that was up only slightly from a month earlier. An inverted yield curve has traditionally signaled that bond investors expect a recession within a year and a lowering of interest rates by the Federal Reserve. Demand for bonds pushes their prices down. But the reverse has happened over recent days, with the selling of longer-term Treasury securities pushing yields up rapidly.
Another way to illustrate the phenomenon is to look at how the Federal Reserve has shifted the U.S. money supply. Odeon Capital analyst Dick Bove wrote in a note to clients on Friday that “the Federal Reserve has not deviated from its policy to defeat inflation by tightening monetary policy,” as it has shrunk its balance sheet (mostly Treasury securities) to $8.1 trillion from $9 trillion in March 2022. He added: “The M2 money supply was $21.8 trillion in March 2022; today it is $20.8 trillion. You cannot get tighter than these numbers indicate.”
Then on Tuesday, Bove illustrated the Fed’s tightening and the movement of the 10-year yield with two charts:
Bove said he believes the bond market has gotten it wrong, with the inverted yield curve reflecting expectations of rate cuts next year. If he is correct, investors can expect longer-term yields to keep shooting up and a normalization of the yield curve.
This has set up a brutal environment for utility stocks, which are typically desired by investors who are seeking dividend income. In a market in which you can receive a yield of 5.5% with little risk over the short term, and in which you can lock in a long-term yield of about 5%, why take a risk in the stock market? And if you believe that the core inflation rate of 3.7% makes a 5% yield seem paltry, keep in mind that not all investors think the same way. Many worry less about the inflation rate because large components of official inflation calculations, such as home prices and car prices, don’t affect everyone every year.
We cannot know when this current selloff of longer-term bonds will end, or how much of an effect it will have on the stock market. But sharp declines in the stock market can set up attractive price points for investors looking to go in for the long haul.
Screening for lower valuations and high ratings
A combination of rising earnings estimates and price declines could shed light on potential buying opportunities, based on forward price-to-earnings ratios.
Let’s look at the sectors again, in the same order, this time to show their forward P/E ratios, based on weighted rolling 12-month consensus estimates for earnings per share among analysts polled by FactSet:
There is a limit to how many columns we can show in the table. The S&P 500’s forward P/E ratio is now 17.94, compared with 16.79 at the end of 2022 and 21.53 at the end of 2021. The benchmark index’s P/E is above its 10- and 15-year average levels but below the five-year average.
If we compare the current sector P/E numbers to 5-, 10- and 15-year averages, we can see that the current levels are below all three averages for four sectors: utilities, real estate, financials and communications services. The first three face obvious difficulties as they adjust to the rising-rate environment, while the real-estate sector reels from continuing low usage rates for office buildings, from the change in behavior brought about by the COVID-19 pandemic.
Your own opinions, along with the pricing for some sectors, might drive some investment choices.
A broader screen of the S&P 500 might point to companies for you to research further.
We narrowed the S&P 500 as follows:
- Current forward P/E below 5-, 10- and 15-year average valuations. For stocks with negative earnings-per-share estimates for the next 12 months, there is no forward P/E ratio so they were excluded. For stocks listed for less than 15 years, we required at least a 5-year average P/E for comparison. This brought the list down to 138 companies.
- “Buy” or equivalent ratings from at least two-thirds of analysts: 41 companies.
Here are the 20 companies that passed the screen, for which analysts’ price targets imply the highest upside potential over the next 12 months.
There is too much data for one table, so first we will show the P/E information:
|Company||Ticker||Current P/E to 5-year average||Current P/E to 10-year average||Current P/E to 15-year average|
|SolarEdge Technologies Inc.||SEDG||89%||N/A||N/A|
|United Airlines Holdings Inc.||UAL||42%||50%||N/A|
|Alaska Air Group Inc.||ALK||51%||57%||N/A|
|Delta Air Lines Inc.||DAL||60%||63%||21%|
|Alexandria Real Estate Equities Inc.||ARE||59%||68%||N/A|
|Las Vegas Sands Corp.||LVS||96%||78%||53%|
|Paycom Software Inc.||PAYC||61%||N/A||N/A|
|PayPal Holdings Inc.||PYPL||33%||N/A||N/A|
|SBA Communications Corp. Class A||SBAC||27%||N/A||N/A|
|Advanced Micro Devices Inc.||AMD||58%||39%||N/A|
|Charles Schwab Corp.||SCHW||75%||54%||73%|
|Lamb Weston Holdings Inc.||LW||71%||N/A||N/A|
|News Corp Class A||NWSA||93%||73%||N/A|
|CVS Health Corp.||CVS||75%||61%||67%|
Click on the tickers for more about each company or index.
News Corp NWSA is on the list. The company owns Dow Jones, which in turn owns MarketWatch.
Here’s the list again, with ratings and consensus price-target information:
|Company||Ticker||Share “buy” ratings||Oct. 2 price||Consensus price target||Implied 12-month upside potential|
|SolarEdge Technologies Inc.||SEDG||74%||$122.56||$268.77||119%|
|United Airlines Holdings Inc.||UAL||71%||$41.62||$69.52||67%|
|Alaska Air Group Inc.||ALK||87%||$36.83||$61.31||66%|
|Delta Air Lines Inc.||DAL||95%||$36.45||$58.11||59%|
|Alexandria Real Estate Equities Inc.||ARE||100%||$98.18||$149.45||52%|
|Las Vegas Sands Corp.||LVS||72%||$45.70||$68.15||49%|
|Paycom Software Inc.||PAYC||77%||$260.04||$384.89||48%|
|PayPal Holdings Inc.||PYPL||69%||$58.56||$86.38||48%|
|SBA Communications Corp. Class A||SBAC||68%||$198.24||$276.69||40%|
|Advanced Micro Devices Inc.||AMD||74%||$103.27||$143.07||39%|
|Charles Schwab Corp.||SCHW||77%||$53.55||$72.67||36%|
|Lamb Weston Holdings Inc.||LW||100%||$92.23||$123.50||34%|
|News Corp Class A||NWSA||78%||$20.00||$26.42||32%|
|CVS Health Corp.||CVS||77%||$69.69||$90.88||30%|
A year may actually be a short period for a long-term investor, but 12-month price targets are the norm for analysts working for brokerage companies.