For market investors, today (Sept. 28) is a very different day than the one that came before.
To some extent that is always true — in the stock market every day is different. But for Sept. 28, it’s especially true, due to some big changes in how stocks are officially classified.
How big? Try this on for size:
- Facebook and Alphabet Inc. (Google’s parent) are no longer tech stocks.
- The Telecom sector no longer exists.
Apologies if you spit out your coffee (we wouldn’t blame you). This is a major deal. And it could have a subtle, but lasting impact on investor behavior moving forward.
So, what is happening exactly?
At the heart of things, the powers that be decided that the long-running Telecom sector was too small and too out-of-date to survive.
So, they scrapped the Telecom sector completely, and came up with a new sector to replace it: Communications Services.
As of Sept. 28, all the stocks that used to be in the Telecom sector were assigned to an industry subgroup of the brand-new Communications Services sector.
This part wasn’t a lot of work, actually, because the old Telecom sector had only three stocks left in it: AT&T, Verizon Communications, and Century Link.
The Communications Services sector looks radically different. Here is the biggest surprise: It has Facebook and Alphabet.
This means Facebook and Alphabet, officially speaking, are no longer Technology companies. In the eyes of the indexers, they are now Communications Services companies.
State Street has a new ETF, the Communication Services Select SPDR — symbol XLC — that reflects the new sector composition. It hasn’t been actively trading for long, but the basket of stocks that are included in the Communications Services SPDR would have outperformed the S&P since 2013.
Facebook has an 18 percent weighting in State Street’s new Communication Services ETF. Two different classes of Alphabet stock have a more than 12 percent weighting each (so technically Alphabet is the heaviest weighted company in the ETF, and Facebook is second). Other names in this new sector ETF include Disney, Activision Blizzard, and Netflix.
The change makes a lot of sense. It was odd to have an entire sector (Telecom) that had been whittled down to just three stocks. The old Telecom sector, which no longer exists, had a less than 2 percent weighting in terms of the total S&P 500. The new Communications Services sector will represent more than 10 percent.
These changes will have lasting impacts on investor behavior. It’s more than just the fact that an old sector was retired and a new one was created.
The composition of multiple existing sectors has changed, too. That means behavior moving forward is likely to change — both the behavior of various sectors and the behavior of investors in response to it.
Here is an example of what we mean. The old Telecom sector was entirely composed of value stocks. Communications Services is more than 50 percent oriented to growth stocks (via the adding of Facebook, Alphabet, Netflix, and so on). That means a whole bunch of strategies that treated Telecom as a source of value exposure will have to be scrapped.
It also means the Technology sector, which no longer holds Facebook or Alphabet, is less of a growth-oriented sector than it was before. As a result of the change, the Technology sector will no longer be the sector with the highest percentage of growth stocks in its mix. That distinction will go to the Consumer Discretionary sector.
Individual investors, large institutions, mutual funds, and hedge funds will all change their behavior at the margins because of this. Many back-tested data assumptions based on historical sector behavior will also be degraded or possibly even invalidated. They aren’t the same sectors as before. As a result of moving things around, multiple sectors have experienced a series of organ transplants (or organ removals).
There could also be psychological impacts attached to the fact that Facebook and Alphabet are no longer considered tech stocks. That is hard to wrap one’s head around although, again, the logic of the shift makes sense.
Also, strange: Technically speaking, none of the FANG stocks are tech stocks anymore (if you assume the “A” is for Amazon and not Apple). That is just weird.
It will take some data crunching and close observation to get a handle on how investor behavior will specifically adjust as a result of these shifts. Fortunately, that’s one of the things we’re great at.
We’ll keep you posted on what we find to the degree this big sector shift — and reclassification of bellwether names like Facebook and Alphabet — impacts our market strategies and why.
Richard Smith, PhD
CEO & Founder, TradeSmith