Sector Scan: So long telecom, as markets rejig to reflect digital era

September 20, 2018 Edward Golding

For once, I am 100% confident to predict a big change coming in the stock market you should know about: entire industries are about to be reshuffled.

On September 28th, the S&P 500 Index and MSCI will reorganize how they categorize some of the world’s biggest companies under their Global Industry Classification Standard (GICS). 

Most notably, the old telecommunications services sector, born of traditional operators like AT&T and Verizon, is being expanded and renamed to become “communications services.”

The change won’t likely have any impact on investments (so, sorry if you were waiting to hear a stock tip), but it does call for a closer look at this new sector and the mix of companies in it.

A sector where Facebook, Netflix, AT&T and Disney can hang out together

The index providers are trying to catch up on the way we now communicate with each other and access information and entertainment content, as well as the way companies have converged across industries.

This newly defined sector will move several companies out of the information technology and consumer discretionary sectors, to place telecom carriers alongside media and entertainment companies. 

For the first time, this puts names like Facebook, Disney and 21st Century Fox in the same market category as Alphabet (Google), Twitter and TripAdvisor, to better reflect how businesses have progressed in the internet era — and how we now interact with the world every day.

Doing the shuffle

Why it matters: this changes the view on certain sectors for performance

This new classification will call for new ways of thinking about sector investing, which targets stocks in specific segments of the economy that tend to share characteristics.

The telecommunications sector has long been viewed as a steadfast, defensive sector that offered generous yields and downside protection in volatile environments. The information technology sector could be synonymous with growth.

That line of thinking will no longer apply, as the new communications services sector now includes stocks, such as Facebook and Netflix, that offer little in the way of dividends and might be expected to underperform in a more volatile environment.

In addition, the removal of select companies like Google and Facebook from the information technology category and Netflix from the consumer discretionary group means those two sectors could be expected to offer lower growth profiles than in the past.

A handful of stocks will be highly concentrated

Following the reclassification, the three impacted sectors will be increasingly concentrated in a handful of stocks.

Looking at constituents within the new communications services sector, as of September 11th, five stocks account for almost 75% of the sector’s market capitalization. Google will represent about 30%, followed by Facebook at 17%, AT&T at 10%, Verizon at 9% and Netflix at 6%. 

In the IT category, after the changes, Apple will represent 21% of the sector, followed by Microsoft at 16%. 

In the consumer discretionary sector, Amazon will represent 32% of the sector and Home Depot will represent 10%.

Components of the communications services sector: The Big 5

Source: Goldman Sachs, as of September 11th, 2018

By any other name, stock fundamentals remain the same

I can also tell you with 100% confidence that index classifications are quite arbitrary, and simply mirror new realities. The last major GICS change was two years ago, when real estate was spun out of the financial sector as its own asset class.

While the most recent reclassifications in communication services may affect investors who use exchange-traded index funds to passively track market sectors, they will have minimal impact on our clients’ equity investments here at MD.

Our view on any individual company we actively invest in on your behalf won’t change, regardless of the sector it’s in. Rigorous stock analysis still drives our decisions.

It’s no surprise to us that technology continues to blur divisions between industries. It’s our job to select stocks and identify themes that are reshaping these boundaries so we can invest for the future — not those old lines drawn in the past.

Edward Golding

Edward Golding, CFA, MBA, is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He oversees the Canadian, Dividend and U.S. equity mutual funds and investment pools at the firm.

 

About the Author

Edward Golding

Edward Golding, CFA, MBA, is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He oversees the Canadian, Dividend and U.S. equity mutual funds and investment pools at the firm.

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