An In-Depth Look At The Extended Valuation Of Defensive And Income-Yielding Equity Sectors

Early last week, I highlighted the extended valuation of the utilities sector, in part due to investor demand for income-yielding stocks. Not only are the income sectors attracting investor dollars, defensive sectors like consumer staples are as well. A result of this investor demand for defensive and income producing equities is that these sectors have produced market-beating returns so far in 2016. As the below sector return chart shows, the defensive consumer staples sector and income-yielding sectors like utilities and telecommunications have generated strong returns this year.

However, the strong return in these sectors has pushed the sector valuation beyond the average longer-term valuation for each respective sector itself. The better-performing sectors, utilities and staples, are some of the most extended compared to the other sectors. Energy sector valuations are at extremes, largely due to earnings headwinds resulting from lower oil prices.

Of note is the fact that the telecommunications sector is the second-best performing this year, yet its current valuation, or P/E, remains below its 10-year average.

For utilities, the forward 12-month expected sector earnings growth rate is only 3.4%. In Q1 2016, although earnings were positive for the utilities sector, earnings fell 4.3% as compared to the same quarter last year. Consequently, with utilities trading at a forward P/E of 17.9 times and expected earnings growth of 3.4%, this leaves little margin... Read more