The Stock Market’s Rally Has Made it Expensive. These Stocks Are Still Cheap.

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S&P 500
has rallied a bit more than 20% from its low in early October, and with the market at such an expensive level it is difficult to find promising stocks. The good news is that a few sectors still look cheap. 

The rally has been fueled by the view that economic and corporate earnings growth will stabilize by some point later this year or next year. The Federal Reserve is at—or near—the end of its interest rate hikes, which have already dragged the rate of inflation lower.

Now the S&P 500’s forward price/earnings multiple has landed at almost 19 times, up from just below 16 times at the start of the rally. This is especially high, considering the now-appealing 5% yields on some government debt.

And it isn’t just the Big Tech group—which are up double digits, with some seeing near twofold increases—that is expensive. The median stock on the S&P 500, which accounts for the large market values of the higher-multiple Big Tech group, is still about 17 times. That is above the 20-year average for the median multiple of about 16 times, according to Credit Suisse. 

Fortunately, several sectors are trading at discounts to the index. They still might have a little downside, but their prices are at least accounting for a considerable amount of risk—and the upside seems plentiful. The areas that look especially cheap are regional banking, materials, and pharmaceuticals. 

Start with regional banks. The
SPDR S&P Regional Banking ETF
(ticker: KRE), which includes holdings such as
M&T Bank
) and
Truist Financial
(TFC), is down about 38% from its highest point this year, just weeks before the Silicon Valley Bank collapse. Regional banks took a hit when depositors pulled money out of accounts in search of higher-yielding money-market funds, pressuring banks’ ability to lend and generate earnings—and putting significant strain on their balance sheets. 

Now, the ETF trades at just over eight times earnings, more than 10 points below the S&P 500’s multiple. Historically, the fund trades at a P/E that is only about three points below the index. Shares of banks that haven’t seen depositor runs could quite simply catch a bid soon, while the entire group could also recover if upcoming earnings reports show a stabilization of deposits, a brightening outlook for loan demand, and improving consumer and business credit. 

Some materials stocks are pretty cheap, too. The entire group is cheaper relative to the S&P 500 than it has been historically, but some of the cheapest names are more than seven multiple points below the broader index, versus about in-line historically. Those are the materials names outside of metals and chemicals.

International Paper
(IP), $10.7 billion by market value and maker of industrial packaging, printing paper, and other products, trades at just over 12 times earnings.
(WRK), the $7 billion fiber-based paper maker, trades at 11 times earnings. If the market grows more confident in consumer demand across the board, it will grow more confident in these companies’ earnings—and send their stocks higher. 

And then there is pharma. The group trades at a multiple about five points lower than the market, versus one point lower historically. Drugmaker
Bristol Myers Squibb
(BMY) trades at about eight times earnings. A patent expiration on its myeloma treatment, Revlimid, is pressuring market share for the drug, so as the company moves closer to getting brand new drugs to market, the stock could pick up some steam. 

In a market without many bargains, these stocks might be the closest things to steals. 

Write to Jacob Sonenshine at [email protected]

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