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Schwab Sector Views: Miss-Communication

By Brad Sorensen
Key Points
  • The communication services sector is still relatively new, but has outperformed year to date, defying our underperform rating. 

  • Headwinds appear to be building for the group, and we believe competition, costs, and regulatory issues will become increasingly problematic.

  • We suggest investors continue to have caution with regard to the communication sector, and look to take some profits if needed to reduce an overweight position.

Schwab Sector Views is our three- to six-month outlook for 11 stock sectors, which represent broad sectors of the economy. It is designed for investors looking for tactical ideas. We typically update our views every two weeks. 
Any mention of specific companies is for illustration or reference purposes only and should not be construed as an opinion on the company as an investment. 

Listen to the latest audio Schwab Sector Views.

 

Star-struck?

A confession: I am not a member or user of Facebook or Netflix, don’t go to Disney parks and don’t really use Google all that much—which are four of the largest companies in the communication services sector. Whether that makes me old and out of touch—or smart—I leave to you, but I am quite aware of all of these services and can appreciate the businesses they have grown. However, it also appears to me that investors have gotten a bit carried away with this group and have overlooked some of the substantial headwinds that I believe much of the group is facing. 

The communication services sector is relatively new—it was formed late last year when the telecommunications sector was joined with various media and social media-related names. And there’s no doubt that some of the most highly visible companies with exciting news and developments are members of the group, a sample of which are mentioned above. But roughly 20% of the sector is made up of former members of the telecom group, which has actually lagged market performance year to date. That’s not too surprising given the traditional defensive nature of that group, and the more-cyclical nature of the year-to-date rally. 

But there are exciting possibilities within the sector as well—namely 5G wireless technology. Reportedly it would allow movies to be downloaded in seconds instead of minutes, and the number of devices supported within a square kilometer is estimated to be about 1 million with 5G, compared to 2,000 with 4G (The Wall Street Journal). 

However, there are also challenges. One of the most recent is the American government’s restrictions on doing business with Chinese tech giant Huawei, one of the leading providers of 5G technology (Bloomberg). Additionally, without getting too technical, the millimeter waves that make up 5G have plusses and minuses—with one of the minuses being that the waves can’t penetrate walls and have trouble with hands, heads and things such as tree leaves (EDN Network). An advantage is that the antennas are quite small, allowing them to be placed in a wide variety of locations. But this is going to cost money and take time, which could cause some problems for these stocks in the coming months as some of the excitement wears off and reality seeps in. 

That could also occur with much of the rest of the sector. Investors appear quite excited about the content coming out of some of the group and the advertising possibilities with the reach of companies such as Facebook and Google (Alphabet). But there are only so many advertising dollars to be had and the competition is fierce. We are concerned that we may be reaching the point of saturation, where new users of some services are tough to come by—both because of these companies’ reach as well as the apparent maturing of the millennial generation. Admittedly, I have no way to prove what habits will change and which won’t, but we can see that more housing formations are occurring and it seems to me that with the purchase of a house comes more responsibilities, resulting in less time to use some of these services. 

Increased housing formation could lead to habit changes

Household formations, owners vs renters 4Q MAV Yearly change

Competition also appears to be increasing. Although perhaps not a complete list, a report from Consumer Reports shows that as of the end of April there were at least 19 different streaming services to choose from—ranging from $5-$90 per month. It’s a little joke around our office that someday people will look at their various streaming bills and wish for one, consolidated service that gave them what they wanted—a return to the past, perhaps! But given this competition, the costs to obtain content appears to be escalating. Just last month, for example, one of the most popular streaming services, Netflix, announced that its cash burn for 2019 was going to be $3.5 billion in 2019—up $500 million in just four months—largely due to content costs. And they have had negative cash flow every year since 2011, resulting in their debt rising, growing by roughly $4 billion over the past 12 months (BusinessInsider.com). I point this out not so much to highlight a specific company, but to illustrate the willingness of one of the leaders to spend on content, which I believe will have to trickle down to escalating costs for competitors. 

And finally there are the regulatory challenges facing much of the group. Privacy concerns seem to be in vogue with both political parties, and could result in restrictions on data collection that would make the advertising options potentially less valuable. We’ve already seen the European Union implement the General Data Protection Regulation, which sharply limits the ability of companies to collect and use personal data in their business activities (EUGDPR.org), and a regulation that some politicians in the U.S. have pointed to as an example to follow (The Wall Street Journal). Additionally, there have been concerns expressed about the size and power of some of these companies. For example, recently, presidential candidates Elizabeth Warren and Kamala Harris, along with Facebook co-founder Chris Hughes, have called for the breakup of Facebook, a company that makes up roughly 20% of the communication services sector. While I don’t think such an action is imminent, the risk of some sort of onerous governmental action appears to be growing. 

As mentioned, there are a lot of exciting developments occurring in the communication services sector, which are getting a lot of attention. But I believe I’ve outlined some fairly substantial possible challenges facing much of the group, making the risk/reward potential relatively unfavorable, in my view. As such, we are keeping our underperform rating on the sector and suggest investors use caution when looking at the group. 

Schwab Sector Views: Our current outlook

Sector

Schwab Sector View

Date of last change to Schwab Sector View

Share of the
S&P 500 Index

Year-to-date total return as of 5/21/19

Communications Underperform 09/28/2018 10% 19.18%

Consumer discretionary

Marketperform

07/17/2014

10%

18.07%

Consumer staples

Marketperform

05/07/2015

7%

14.32%

Energy

Marketperform

11/20/2014

5%

13.47%

Financials

Marketperform

08/16/2018

13%

14.69%

Health care

Outperform

01/26/2017

14%

3.57%

Industrials

Marketperform

01/29/2015

10%

17.98%

Information technology

Marketperform

08/16/2018

22%

21.47%

Materials

Marketperform

01/31/2013

3%

8.80%

Real estate

Marketperform

08/16/2018

3%

18.07%

Utilities

Marketperform

08/16/2018

3%

12.27%

S&P 500®  Index (Large Cap)

 

 

 

15.18%

Source: Schwab Center for Financial Research and Standard and Poor’s as of 4/30/19.

 

Clients can use the Portfolio Checkup tool to help ascertain and manage sector allocations.

What is Schwab Sector Views?

Schwab Sector Views is our three- to six-month outlook for 11 stock market sectors, which are based on the 11 broad sectors of the economy.

The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:

  • Outperform: Likely to perform better than the rest of the market.
  • Underperform: Likely to perform worse than the rest of the market.
  • Marketperform: Likely to track the broad market.

How should I use Schwab Sector Views?

Investors should generally be well-diversified across all stock market sectors. You can use the Standard & Poor’s 500 allocations to each sector, listed in the chart above, as a guideline.

Investors who want to make tactical shifts in their portfolio can use Schwab Sector Views’ outperform, underperform and marketperform ratings as a resource. These ratings can be helpful in evaluating and monitoring the domestic equity portion of your portfolio.

Schwab Sector Views can also be useful in identifying stocks by sector for potential purchase or sale. When it’s time to make adjustments, Schwab clients can use the Stock Screener or Mutual Fund Screener to help identify buy or sell candidates in particular sectors. Schwab Equity Ratings also can provide an objective and powerful approach for helping you select and monitor stocks.

What you can do next

Schwab Market Update
Real Estate Sector Rating: Marketperform
Real estate sector

Important Disclosures

Schwab Sector Views do not represent a personalized recommendation of a particular investment strategy to you. You should not buy or sell an investment without first considering whether it is appropriate for you and your portfolio. Additionally, you should review and consider any recent market news. Supporting documentation for any claims or statistical information is available upon request.

All expressions of opinion are subject to change without notice in reaction to shifting market or other conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. The above mentioned companies should not be construed as a recommendation or endorsement.

Diversification and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.

The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.

The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of Morgan Stanley Capital International Inc. (MSCI) and Standard & Poor's. GICS is a service mark of MSCI and S&P and has been licensed for use by Charles Schwab & Co., Inc.

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