The latest sell-off in US stocks, coupled with what has so far been a solid earnings season, has reduced the valuations of S&P 500 companies to near historical averages. David Kelly, chief global market strategist at jpmorgan Asset Management, said this combination presents an opportunity for investors to consider value stocks. However, the strategist remains cautious on large-cap tech stocks as the group's price-to-earnings ratio remains high relative to historical levels.

The S&P 500 is down 10 per cent from its July peak, and third-quarter earnings are on track to grow 2.1 per cent, leaving the index trading at nearly 20 times earnings, compared with its long-term average of more than 16. Excluding the 10 largest companies, which are mostly large tech companies, the P/E ratio is 15.6. Together, these 10 heavyweights trade at 26 times forward earnings, about 131% above their long-term average price-to-earnings ratio.

While Kelly recommends looking at value stocks - which look relatively cheap compared to fundamentals - he's not saying it's a categorical decision, given the headwinds from rising interest rates and geopolitical turmoil. Kelly said in a telephone interview, "The opportunity for U.S. equities looks better than it has in quite some time." You just have to have the courage to enter."

The rise in Treasury yields has sapped demand for risky assets. Through June, S&P 500 companies' profits had fallen for two straight quarters. Kelly said that while valuation multiples for big companies have always been high, the gap between them and the rest of the market has grown too wide. "I'd rather be underweight large-cap stocks and overweight value stocks and let inflation come down," he says. Among sectors, he likes energy and financials.

Jpmorgan forecasts that inflation will fall to 2% by the fourth quarter of 2024. Kelly noted that some of the cheapest industries could do better if the U.S. economy were not severely damaged. As for small-cap stocks, Kelly said he's "still pretty upset" that almost half of the companies in the Russell 2000 are "actually not profitable."

The index is now near levels last seen in October 2020 and 10% below its long-term 200-day moving average, with 75% of the Russell 2000 already in bear market territory. With the threat of a recession looming, it's still too early to buy small-cap stocks. "I would rather come in after we see a certain amount of economic disruption," Kelly said.