One of the stock market's biggest problems is how a handful of technology stocks continue to gobble up more of the market. Tech has grown to be roughly 26 percent of the S&P 500, a level that worries many investors. Apple, Microsoft and Amazon alone have consumed 4 percentage points of a $20-trillion-plus equity market in less than three years, according to DataTrek Research. Facebook, Amazon, Apple, Microsoft and Alphabet represent an S&P 500 market weighting (15.6 percent) that is greater than either the health-care or financials sector.
That's why on Monday morning the S&P 500 is taking a crack at fixing its big tech problem.
Some of the market's leading tech stocks — Alphabet, Facebook and Netflix — are moving to a new communications sector that replaces telecom in a reshuffling of market capitalization near-$3 trillion. Many investors and market strategists say the reshuffling of major tech stocks between the technology, consumer discretionary and communications sectors won't solve the problem of big tech's influence in the market, but it will have major implications for investors. In fact, the changes will have the biggest impact on the sector landscape in the history of the contemporary GICS sector classification system, according to State Street Global Advisors.
"It is very important for investors to understand how the reclassification will affect their portfolios, since the ETFs that they currently hold may no longer suit their investment objectives," said Neena Mishra, director of ETF research at Zacks Investment Research.
Here is a breakdown of some of the most important repercussions of the S&P sector swaps.
The $23 billion Technology Select SPDR Fund (XLK) is caught in the crosshairs of these stock moves. DataTrek Research co-founder Nick Colas noted that an active manager of a $20-billion-plus fund would not likely dump two of their largest holdings and reweight the top position to close to 20 percent (Apple, in this case) all on the same day, but that's what is happening as of Monday morning.
Specifically, Alphabet, with over a 10 percent weighting in XLK, will move to the new communications services sector, where it will be triple that weight. Facebook, a 5.6 percent weighting in XLK, also will close to triple its weight in Communication Services, according to CFRA data. Those moves will lead to a major decline in the dividend yield of the former telecom sector, too.
If moves of this type were to occur in an actively managed fund, shareholders "would likely flee," Colas wrote in a recent research note. But in index investing it's just the norm. And that leaves big questions for investors about both growth and value investing, sources of dividend income and sector trades.
"Understand it is a different animal come Monday," Colas wrote, and ask yourself, "Do you still want to own it?"
In creating the communications services sector — which now has its own ETF, the Communication Services Select Sector SPDR (XLC) — the S&P has eliminated one the market's most popular defensive equity plays.
"The real hole that will emerge is a reduced number of defensive GICS [sectors]," said Kim Arthur of investment company Main Management, which uses ETFs in its strategies. He said with telecom gone, all that is left as a true defensive sector is consumer staples, represented by the Consumer Staples Select Sector SPDR ETF (XLP).
"The telecom sector is traditionally seen as a defensive sector and a value play. The revamped communications services sector will be seen as a cyclical sector with much stronger growth prospects," Mishra said.
During the current bull market run led by growth stocks, some market strategists have claimed value investing is dead. The big sector moves offer some support for that theory. The new communications index will be 61 percent growth stocks, whereas the telecom index was 100 percent value stocks.
Other sectors with defensive aspects don't offer the combination that telecom did: The ETFs tracking utilities (XLU) and energy (XLE) are a mix of interest-rate sensitivity/defensive, while the health-care ETF (XLV) is growth/defensive.
State Street said the moves are resulting in "sector-growth opportunities becoming more widespread," but the new communications index and ETF have their own high-flying stocks' concentration issue.
Alphabet and Facebook comprise roughly 45 percent of the index — close to 29 percent for Alphabet and 16 percent for Facebook. As concentrated as the technology sector may look, its top two names (Apple and Microsoft) are roughly 30 percent of the group. This new communications sector will have greater concentration in its top 10 holdings than either the tech or consumer discretionary sector.
Tech stocks will comprise more than half of the new sector, over 52 percent; consumer stocks led by Netflix will make up another 28 percent; and telecom stocks will represent less than 20 percent. CFRA estimates the forward-earnings P/E multiple for the new sector could be as high as 28x versus under 11x for telecom currently.
The communications services index also increases from representing about 2 percent of the S&P 500 when it was telecom, to near-10 percent of the S&P 500 with its new additions. It will also have a higher percentage of growth stocks (61 percent) than information technology (47 percent), according to State Street.
CFRA noted in a research report that even as several media companies with above-market dividend yields join the new group, the sharp reduction in AT&T and Verizon representation in the new communications index will weigh down the dividend yield of the historically defensive sector. "Smaller market caps from the dividend-paying media companies won't offset the lack of dividends at heavyweights Alphabet and Facebook," said CFRA investment strategist Lindsey Bell.
While telecom currently boasts a dividend yield of 5.4 percent, the highest in the S&P 500 index, the dividend yield for the new communication services sector will shrink to 1.7 percent. That is below the 1.9 percent offered by the broad S&P 500 index. But giving up its bond-proxy properties does have its advantages: Communications services will have 13 stocks that rank among the top 50 percent of performers this year; the telecom index had none.
It also will have much greater correlation to the S&P 500 overall, with CFRA estimating an increase from 0.6 to 1.0. Several market strategists said that in trying to solve the tech problem, S&P basically has created a mini version of the S&P 500, which will keep its volatility low but will be hard for investors or financial advisors to find enticing. "XLC, with top-line growth at 5 percent, looks a lot like the S&P," Arthur of Main Management said. "The historic P/E has been above the S&P by a few points, beta is 1.05x the market, and dividend yield is below the market."
Tech's overall weighting in the S&P 500 is going down, from roughly 26 percent to 20 percent. On the surface, that seems good.
Arthur noted that historically when a sector approached 30 percent of the S&P 500 (energy in the early '80s, tech in 2000 and financials in 2007), the markets suffered. But moving around big tech stocks from sector to sector may obscure the problem for the marker rather than solve it. Tech is still too big, even if its sector weighting goes down on the surface.
Consider some of the weightings mentioned above, including Apple headed to near-20 percent of tech and Alphabet 25 percent of communications services. Amazon, which stays in consumer discretionary, will now represent close to 30 percent of that sector, with Disney and Comcast moving to communications services.
"Regardless of what you call it, technology's disruptive influence on society and 'passive' investing is unlikely to slow," Colas wrote in a recent research note. Noting the current 15.6 percent weighting of the S&P 500 in just five stocks, he asks, "Where will this weighting be in 5 years? We sincerely doubt it will be lower."
No comments:
Post a Comment