The table below displays the current and historical CAPE ratios by Sector, calculated using the 500 largest publicly traded U.S. companies. If a sector’s cyclically adjusted price-to-earnings (CAPE) ratio is below its historical average, it may suggest the sector is undervalued, and vice versa.

The CAPE ratio varies significantly across different stock market sectors, clearly reflecting the current market sentiment and investors’ risk appetite. Over the past few years, there has been a notable increase in the CAPE multiples for the Communication Services, Consumer Discretionary, and Information Technology sectors. In contrast, sectors like Energy and Materials have seen little to no change in their CAPE ratios. Among the largest companies: Apple Inc., Microsoft Corp., & Nvidia Corp. are part of the Information Technology sector; Amazon.com Inc. & Tesla Inc. fall under the Consumer Discretionary sector; and Alphabet Inc. & Meta Platforms Inc. belong to the Communication Services sector.

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CAPE Ratio by Sector (Large Cap U.S. Companies)

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Cyclically Adjusted P/E & Sector Performance

The CAPE ratio (Cyclically Adjusted Price-to-Earnings ratio, also known as the Shiller P/E) is a valuation metric that compares a company’s stock price to its average earnings over the past 10 years, adjusted for inflation. It provides a more stable measure of valuation than the traditional P/E ratio by smoothing out the effects of business cycles.

The ratio was originally developed by Professor Shiller to estimate the overall valuation of the U.S stock market but can the CAPE ratio be used to predict the future performance of a specific market sector or industry? In a white paper published by Barclay’s research department and Professor Shiller (to promote the new ETN/Exchange Traded Note), the group developed a sector rotation strategy that outperformed annual returns of the S&P 500 total return index with nearly 4%. The returns are promising but it is always easy to beat the market using historical data. Time will tell whether the CAPE ratio will remain as a useful measure in the future.

Comparing the valuations of different Sectors using the CAPE ratio

Comparing the valuations of different industries can be tricky due to the diverse economic trends and growth prospects across sectors. Each industry operates under unique conditions that influence its valuation, making direct comparisons difficult. For example, technology companies have much higher growth expectations compared to more stable sectors like utilities, leading to higher CAPE ratios for tech stocks. This reflects the market’s optimism about long-term growth potential in technology, even though earnings may fluctuate more significantly than in other sectors.

Furthermore, some industries are more cyclical than others, meaning their performance is closely tied to economic conditions. For instance, Consumer Discretionary companies, which rely on consumer spending that varies with economic cycles, are more sensitive to economic booms and busts than Consumer Staples companies. The cyclicality of certain sectors causes their earnings to swing more widely, which, even with the 10-year smoothing effect in the CAPE ratio, can still influence the metric’s accuracy.

The CAPE ratio works most effectively when used to compare a sector’s current CAPE ratio to its historical average. This approach provides a clearer picture of whether a sector is overvalued or undervalued in relation to its own long-term trends, accounting for factors like cyclical fluctuations. By examining the current ratio in this context, investors can better assess whether the sector’s valuation is reasonable or if market sentiment is overly optimistic or pessimistic.