As the market changes, so too must the systems used to track it.
In September 2018, S&P Dow Jones and MSCI, creators of the Global Industry Classification Standard (GICS®)—which separates more than 29,000 stocks into 11 major market sectors—adjusted three of those sectors to better reflect the breadth, depth and evolution of the market.
Of all the changes, those to Telecommunication Services—now known as Communication Services—may be the most dramatic. Let’s take a look at what’s behind the changes and what they might mean for investors.
Traditional telecommunication services (think fax and landlines) have long been moving toward obsolescence. At the same time, the ways in which we communicate—from email and text to Skype and all manner of social media—have never been more varied.
This evolution helps explain why technology-based social media platforms such as Facebook and Twitter—along with Alphabet, the parent of search giant Google—were shifted from the Information Technology sector into the new Communication Services sector. Several media companies—including Netflix and Walt Disney—also decamped for the new Communication Services sector, from Consumer Discretionary (see “Introducing: Communication Services,” below).
With so many large companies shifting places, the effects on the sector composition of the S&P 500® Index are significant. Before the shuffle, Information Technology represented 26.5% of the S&P 500 Index; now it’s just 21%. And Telecommunication Services made up a scant 1.9%, whereas its successor, Communication Services, accounts for 10%.
So, what are the consequences for investors?
Before the change, Telecommunication Services, with its relatively high dividends and stable earnings, was an attractive option for investors looking to play defense during a downturn. But with the addition of low-dividend-paying tech companies, the new Communication Services sector may no longer be the defensive darling its predecessor was. Indeed, the sector’s dividend yield has fallen from 5.4% to just 1.5%1—well below the S&P 500’s yield of 1.9%.2
Information Technology, on the other hand, may prove more defensive than it once was. While the sector’s dividend yield increased only slightly as a result of the reclassifications—from 1.2% to 1.5%—its return on equity rose from 28.5% to 31.4%.3 Together, these increases suggest the Information Technology sector may be better positioned to weather a market downturn than in the past.
Many of the big-name technology companies have long been known for their stellar growth. Because of that, investors may assume Communication Services is destined to be a fast mover. That may not be the case.
Many companies in the sector are locked in a fierce and expensive battle for consumers’ finite attention. Netflix alone has committed to spending $18.6 billion on content in the coming years, even as AT&T looks to unveil a streaming service built around HBO as part of its $85.4 billion acquisition of Time Warner. And both AT&T and Verizon are in the midst of launching competing next-generation cellular wireless services.
Proceed with caution
While companies in the Communication Services sector should continue to grow, profits may dwindle as competition intensifies and costs rise—which is one reason we’ve rated the sector Underperform. Those looking to play defense may want to consider Information Technology or one of the other traditionally defensive sectors (Consumer Staples, Health Care and Utilities, for example), while those looking for growth may want to consider Consumer Discretionary and Industrials.
That said, growth stocks may struggle in the later stages of the business cycle, when defensive positions can make more sense. Investors looking to add more growth-oriented stocks to their portfolios should be careful not to overdo it, lest they leave themselves overly exposed to a pullback.
1Schwab.com, as of 10/25/2018.
2Standard & Poor’s, as of 09/28/2018.
3Cornerstone Macro Research, as of 07/23/2018.