It may seem absurd for me to make this prediction but I believe that despite current volatility, the market actually has further left to run.
There are currently many different analysts all stating why they believe the market is overvalued and due for a pullback, however, a quick evaluation of the market by one of the simplest methods around quickly shows that the market could actually be undervalued.
The S&P 500 has traded at an average forward P/E of 15.10 for the last 27 years; currently, the index is trading at a forward P/E of 14.24, 6% below its 27-year average. Moreover, according to the same set of data, the index is trading 17% below its average price-to-book ratio average for the same 27 year period.
While the S&P 500 as a whole is undervalued, the majority of the index is being pushed higher by several overvalued sectors. In particular, the consumer discretionary sector is trading 10% above its 27-year average P/E ratio and 40% above its average P/B ratio. In fact, it would appear that the consumer discretionary sector is the most overvalued sector in the index, as the sector is also trading at a 27% premium to its price to operating cash flow ratio.
Alongside the consumer discretionary sector, the utilities sector is also overvalued compared to its 27-year average. On a forward P/E basis the sector is trading at a 19% premium to its historic average and a 6% premium to its historic P/B ratio.
But hang on, some sectors are still undervalued
Yes, even in this supposedly overbought and tired market, there are still some sectors that are undervalued relative to their historic averages. Surprisingly, one of the most undervalued sectors is the relatively defensive healthcare sector, which is trading at a 28% discount to its 27-year average price-to-operating-cash-flow figure, a 36% discount to its historic P/B ratio and an 8% discount to its historic forward (which sounds like it is a contradiction in terms) P/E ratio.
Aside from healthcare, the energy sector also appears undervalued and currently trades at a 16% discount to its historic P/B ratio, 12% discount to its historic price to free cash flow ratio and 17% discount to its 27-year average forward P/E ratio.
Unsurprisingly, the financial sector is still undervalued relative to its 27-year average P/B ratio and is currently trading at a 26% discount. However, the sector is trading at a 16% premium to its 27-year average forward P/E ratio.
All this is helpful, but are there any individual opportunities?
Using the above data to identify picks in this uncertain market has led me straight to healthcare plan provider WellPoint, Inc. (NYSE:WLP). WellPoint, Inc. (NYSE:WLP) is currently trading at a P/E of 9.2 and a forward P/E of 9.45, both significantly below the healthcare sector average P/E of 30.5 and the company’s sub-sector, healthcare plans, which is trading at an average P/E of 13.8. The healthcare plan sub-sector trades at an average price to free cash flow ratio of 78.1; meanwhile WellPoint, Inc. (NYSE:WLP) has a P/FCF ratio of 15. Moreover, WellPoint, Inc. (NYSE:WLP) trades at a P/B ratio of around 1, 40% below the healthcare sector average of 1.8.
