Having just written about what I consider to be favorable market valuations, I wanted to take a closer look at the market to see where the values lie within it. A good way to do this, I think, is to look past the index valuation and see how the equal-weighted segments of the market are valued. The S&P 500 Equal Weight index ended 2018 with a forward P/E of 14.6, a discount of about 6% to the forward P/E of the parent index.
What are the sources of this discount?
It is important to note that there are large differences in the sector exposures of the S&P 500 index and its equal-weighted counterpart. Most recently, those differences were significant in the industrial, technology, and consumer discretionary spaces:
However, we also have to account for valuation differences within each sector. Using forward P/E ratios for each sector of the index, it is interesting to note that the biggest valuation discrepancy is in consumer discretionary, which is undoubtedly the result of Amazon now composing more than 23% of the capitalization-weighted consumer discretionary index. Other notable discounts appear in staples, technology, and industrial stocks.
It is worth noting that while the equal-weight valuation is seemingly most favorable in consumer discretionary, it should be remembered that, historically, equal-weighting has been a poor strategy in consumer discretionary stocks, leaving me to conclude that the most favorable exposures currently in equal-weighting are likely in industrials, information technology, and elsewhere.