If you want to be in the S&P 500 at all, which I’d rather not, you want to be in energy. Energy is very cheap on a valuation basis compared to other sectors. Oil/liquids aren’t projected to grow very fast, according to the Energy Information Administration. Insiders are generally quite bearish but buying above the historical average rate in energy.
Energy is cheap
If you divided the S&P 500 up into 11 sectors, you can calculate a separate Shiller P/E ratio for every segment. The Shiller P/E for the entire market is currently very high, as discussed in Stock Market 2nd Highest Valuation In History. There are definitely some sector differences with the cheapest one. Energy is trading at a 18.3x multiple, which is around the historical average, while real estate trades near a 50x multiple. The table below shows both the Shiller P/E (a 10-year average figure) and the less useful current P/E.
| Sector | Number of Stocks | Shiller P/E | Regular P/E |
| Energy | 32 | 18.30 | -108.10 |
| Consumer Defensive | 38 | 22.40 | 19.10 |
| Utilities | 28 | 25.20 | 31.90 |
| Financial Services | 73 | 25.80 | 17.10 |
| Industrials | 70 | 26.10 | 23.00 |
| Consumer Cyclical | 82 | 27.60 | 22.00 |
| Healthcare | 62 | 29.70 | 22.90 |
| Communication Services | 10 | 30.20 | 20.70 |
| Technology | 61 | 33.80 | 25.70 |
| Basic Materials | 22 | 34.10 | 28.70 |
| Real Estate | 28 | 49.50 | 28.50 |
| S&P 500 | 500 | 30.9 | 25 |
Data: gurufocus
The Shiller P/E has historically been a good predictor of future returns. When it’s high, future returns have mostly been low -- either through many years of low or slightly negative returns or through financial shock therapy. Energy and consumer defensive stocks as a group look like the best bets within the S&P 500.
Oil production
Oil prices are famously unpredictable, or at least they are to most people (myself included). Between the supply and demand side, the supply side is easier to forecast. Just think about the huge multi-billion-dollar projects that players like Exxon (XOM) and Royal Dutch Shell (RDS.A) undertake to increase supply. Especially on a short-term basis, organisations like the IEA are probably fairly accurate. It's interesting that their projections for petroleum and other liquids show only very limited production growth until 2028.
U.S. production is hitting a new record high and projected to continue to rise beyond 2018:
But even with the record U.S. production, their forecast is for Brent at $52 per barrel in 2018:
Global oil inventories are forecast to be relatively unchanged in the second half of 2017 before returning to average inventory builds of 0.2 million b/d in 2018. Given this expectation of relative balance in the global oil market through the forecast period, Brent crude oil spot prices are expected to remain fairly flat in the coming months.
Insider buying
Meanwhile, insider buying has been quite strong. On average, insider buying in the S&P 500 is currently very weak. Sectors that buck this trend are energy and financial services where insiders are buying at above-average rates.
Insider buying has historically been predictive of future returns. In energy, insider buying is currently 25% above the historically average rate, while the S&P 500 in general is about 25% below the historical average rate.
Conclusion
The Shiller P/E ratio and other valuation metrics do not inspire me to go on an index-wide buying spree. My suspicion is that the Energy Select Sector SPDR Fund (XLE, Financial), which pretty much represents every energy stock in the S&P 500, will outperform the S&P 500 ETF (SPY, Financial) over the next five years. I’m not all that confident on the timing of energy coming back but valuations, limited global supply growth and insiders buying at an above-average rate convince me it will at some point. If you want to look for value in the S&P 500, look at energy first and defensive stocks second.
Disclosure: no positions.
