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The Most Overvalued and Undervalued Stock Market Sectors of 2019

John Divine

Least to most attractive sectors in 2019.

Of the 11 stock market sectors, only three -- materials, consumer staples and consumer discretionary -- are currently valued near their 20-year averages. Of the other eight, two are historically overpriced while the other six appear cheap. If the last months of 2018 are any indication of what is in store for 2019, this looks to be a choppy year on Wall Street, and investors will need all the help they can get. Starting with the most overvalued and finishing up with the cheapest and best sectors to invest in, here's a look at the eight sectors to watch in 2019.

Real estate (overvalued)

Before making any assumptions here, let's just get this out of the way: We're not looking at another real estate bubble circa 2007. Firstly, the S&P 500 real estate sector, which primarily consists of real estate investment trusts, property managers and developers, isn't a proxy for housing prices. Still, although not ridiculously inflated, real estate appears to be one of the two priciest S&P sectors in 2019. Its poor 4.9 percent weighting in the Russell 1000 Value Index shows how quantitatively unlikeable this stock market sector is currently.

Forward price-earnings ratio: 16.5

20-year average: 15.3

Dividend yield: 3.8 percent

20-year average: 4.4 percent

Utilities (overvalued)

Investors historically turn to utilities in times of uncertainty, and 2018 was no different. It was one of only two sectors to gain more than 4 percent (adding 4.1 percent) last year, and with interest rates still quite low historically speaking, high-dividend yields in utilities stocks have been luring income investors to the sector. Arguably too many, in fact, as the sector both trades at higher-than-average valuations and offers a lower-than-average yield, indicating the famously defensive sector may be overbought. As rates rise, dividend stocks lose some appeal as better fixed income opportunities materialize.

Forward P/E ratio: 16.2

20-year average: 14.2

Dividend yield: 3.7 percent

20-year average: 4 percent

Communication services (undervalued)

Despite a bull market that's closing in on its 10th birthday, the majority of the 11 S&P 500 sectors look plain cheap entering 2019. Communication services, the stock market's newest sector, is one of them. Formerly the telecom sector, it was recategorized in late 2018 as rapid consolidation and a slew of mergers and acquisitions saw telecom giants increasingly enter the media, entertainment, and internet categories. The new sector features an amalgam of traditional telecom and companies like Comcast Corp. (ticker: CMCSA), Netflix (NFLX), Alphabet (GOOG, GOOGL) and Facebook (FB). Five-year averages are used for the nascent sector.

Forward P/E ratio: 15.7

Five-year average: 18.2

Dividend yield: 1.7 percent

Five-year average: 1.7 percent

Health care (undervalued)

Next on the list of undervalued stock sectors is health care, which, despite being the top performer in 2018 (up 6.5 percent), nonetheless still trades below its average 20-year multiple. Interestingly, health care is the only sector that's notably overweighted in both the Russell Growth index and the Russell Value index, demonstrating a unique ability to offer investors of all stripes a little something to like. The 2018 midterms were generally seen as a boon to health care stocks, as a split Congress means less uncertainty over the Affordable Care Act's future.

Forward P/E ratio: 14.9

20-year average: 16.9

Dividend yield: 1.9 percent

20-year average: 1.8 percent

Industrials (undervalued)

Decelerating growth in Chinese manufacturing, combined with rising interest rates, had a global impact on the outlook for industrials, which tend to thrive in the early to middle phases of an economic expansion, cooling in the later phases. Overall, cyclical sectors are looking cheaper than its defensive counterparts in early 2019, as the late 2018 swoon helped magnify a rotation into more conservative stocks. Things were going fine in the sector until the fourth quarter, when industrials fell 17.3 percent, finishing 2018 down 13.3 percent. That sell-off helped make industrials clearly undervalued historically.

Forward P/E ratio: 13.6

20-year average: 16.2

Dividend yield: 2.3 percent

20-year average: 2.1 percent

Financials (undervalued)

These last three stock market sectors are the three cheapest in the market in the early days of 2019. Financials are part of that triumvirate with a forward P/E ratio about 18 percent lower than its 20-year average. A higher-than-normal dividend yield also hints at oversold status, while the fact that financials' 22.5 percent weighting in the Russell Value index -- the highest of any sector by far -- further boosts the argument that patient, long-term investors will be rewarded for overweighting the sector themselves. Finally, a rising-rate environment is typically bullish for bank stocks.

Forward P/E ratio: 10.4

20-year average: 12.7

Dividend yield: 2.6 percent

20-year average: 2.3 percent

Energy (undervalued)

The energy sector hasn't been the same since the 2014 sell-off that sent oil prices plunging from over $110 per barrel to a low of just $26 a barrel in under two years. Energy was the single worst-performing sector in 2018, and again, all of the pain came in the fourth quarter. Energy stocks fell 23.8 percent in the fourth quarter, closing down 18.1 percent on the year. A contrarian's dream, the sector yields an incredible 70 percent more than its 20-year average. It's not unreasonable to expect energy to bottom out and rally in 2019.

Forward P/E ratio: 13.7

20-year average: 17.5

Dividend yield: 3.9 percent

20-year average: 2.3 percent

Technology (undervalued)

The last and arguably deepest-value sector on the list is technology. The fourth-quarter sell-off that hit many other stock market sectors on this list began in Silicon Valley, as fears of a slowdown in the semiconductor industry begat a domino effect that eventually engulfed the market itself. Like health care, the tech sector in 2019 offers lots of growth and value opportunities for investors willing to take the plunge. Many of the most anticipated 2019 IPOs will also hail from the tech sector, although whether or not they'll be attractively priced is less clear.

Forward P/E ratio: 15.1

20-year average: 20.6

Dividend yield: 1.9 percent

20-year average: 1 percent

Stock market sector outlooks for 2019.

To recap, here's what investors need to know about the best and worst sectors for 2019 based on historical averages:

-- Real estate (overvalued).

-- Utilities (overvalued).

-- Communication services (undervalued).

-- Health care (undervalued).

-- Industrials (undervalued).

-- Financials (undervalued).

-- Energy (undervalued).

-- Technology (undervalued).

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