U.S. stock-market investors are about to witness something that’s hasn’t been seen in decades: the creation of a new market sector.
Friday will see the launch of the S&P Communications Services sector, a reshuffling of major industry groups that will impact some of the most widely followed and traded names on Wall Street.
The new sector will include companies that are currently in three different industry groups: telecommunications, including Dow components AT&T Inc.
and Verizon Communications
; technology, with Facebook Inc.
and Google-parent Alphabet Inc.
among the most high-profile names moving; and consumer discretionary, where Walt Disney Co.
and Netflix Inc.
are among the stocks making the shift.
The new sector includes both companies that facilitate communication operations, as well as ones that offer the content and information that is spread through various media. The move was seen as a way to address how the primary business of different companies often span multiple sector categories and don’t always reflect the industry they’re currently classified in.
“Ultimately, the new communication service sector will better reflect the rapidly changing way the world’s population communicates,” wrote Lindsey Bell, an investment strategist at CFRA. However, she noted that the change “will result in a more cyclical, lower yielding sector,” in contrast to the defensive posture of the current telecom group.
While the real-estate sector was introduced in 2016 with the components spun out of the financial sector, this marks the first time that a new industry group will be created in this fashion. Morgan Stanley called the realignment “unprecedented” in market history.
The change will take effect after the close of trading on Friday, though it was announced months ago, and many exchange-traded funds and other sector-based strategies have already adjusted their holdings to track the new index.
While the change may not show up in the movements of major indexes, it will substantially change the market’s makeup. The new sector will account for nearly 10% of the S&P 500’s
market capitalization, according to data from CFRA. The weighting of the technology sector will drop from about 26% of the overall market to 21%, though it will remain the single biggest influence. The discretionary sector will drop to 10% from roughly 13%.
The realignment will mean that each of the three impacted sectors will become more concentrated in terms of individual stocks. This could increase the volatility of the sector at large if the biggest stocks see large moves and swamp the influence of smaller stocks.
According to Goldman Sachs, Facebook and Alphabet — which have a combined market capitalization of nearly $1.3 trillion — will together account for 45% of the weighting of the communications sector. Separately, the removal of Netflix and Disney, among other stocks, from the discretionary sector will increase the influence of Amazon.com
After the change, it will account for 32% of the weight of the discretionary sector.
The changes could also alter how investors view the existing sectors. While telecom is considered a defensive group — meaning it tends to have growth that is lower than the overall market, but is more stable — the new additions are seen as cyclical growth stocks. According to CFRA, the telecom sector offers a dividend yield of 5.4%, well above the 1.75% offered by the S&P 500. The yield of the communications sector will be 1.7%, making it less attractive to income-seeking investors.
By including Netflix, Facebook, and Alphabet, the communications sector will house three of the five so-called FAANG stocks, a quintet of stocks that also includes Amazon and Apple
that have fueled much of the market’s gain over the past several years. As a result, the historical performance of the communications sector would have been quite strong. According to Goldman, which conducted a backtest of how the sector would have performed, it has seen twice the risk-adjusted return of telecom stocks since the start of the bull market in 2009.