Finding Value In An Unloved Sector

As the historic bull market in U.S. stocks runs on, concerns about valuations continue to grow. Broadly speaking, finding sector-level value among U.S. stocks is increasingly difficult.

If exchange traded funds dedicated to the value are seen as accurate gauges, the sectors with the most compelling value propositions at the moment are energy and financial services. Focusing on energy, that's the worst-performing sector in the S&P 500 this year and earnings growth estimates for the group have recently been pared in dramatic fashion.

Still, a case can be made that ETFs such as the $1.1 billion iShares Dow Jones US Energy Sector (ETF) IYE currently offer investors value. IYE is down 8 percent year-to-date, but the fund is higher by 2.5 percent over the past month.

Bargain Hunting

The energy sector often trades at a discount to the S&P 500, but today, that discount is more than double the average seen over the previous two-plus decades.

“Energy in particular appears inexpensive relative to the broader market,” according to BlackRock. “Since 1995 the S&P 500 energy sector has traded at approximately a 17% discount to the broader market. Today that discount is nearly 40%.”

For those needing more confirmation that energy is a value play, consider this statistic: The S&P 500 Value Index allocates 11 percent of its weight to the energy sector while the group commands less than 6 percent of the S&P 500's weight.

Oil Prices

IYE allocates nearly 40 percent of its combined weight to Dow components Exxon Mobil Corporation XOM and Chevron Corporation CVX, the two largest U.S. oil companies. That's to say, not surprisingly, that oil prices play a significant role in the performance of IYE and rival equity-based energy ETFs.

“Since late 2015, weekly changes in crude oil have accounted for more than 50% of the variation in weekly returns,” said BlackRock. “In the U.S., energy and financials appear the best way to play the theme, but with the caveat that each is as much driven by their respective fundamentals as style preferences. The good news is that for now, what is good for value—firmer growth—is also good for rates and oil prices.”

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