The S&P 500: Goodbye Telecom, Hello Communication!
The S&P 500 is often used (and cited) as the premier benchmark for the US equity market. In response to questions about stock market performance, most fund managers these days will comment on the S&P 500 – including one or two sectors – and possibly throw in some analyst projections for good measure. Perhaps in a testament to good years and the strong performance of the S&P 500, funds have increasingly flowed into passive investment vehicles like ETFs that track the index. These investors are searching for solid gains with minimal risk (following the diversity is good mantra!), while avoiding the traditionally expensive fees associated with either actively managed funds or mutual funds.
As The Ignorant Investor has mentioned in previous posts, the S&P 500 is a living, breathing composite of various large market-cap companies listed on the NYSE and Nasdaq exchanges. The S&P groups 500 companies into eleven distinct sectors using the Global Industry Classification Standard (GICS). According to S&P Dow Jones Indices, nearly $10 trillion in worldwide investable assets is “indexed or benchmarked to the S&P 500.” Usage can also go far beyond the stock market, too. Want to know how trade policy will affect the US? Look at how various sectors respond to relevant events. In today’s interconnected world - even more so now that a tremendous amount of trading done by algorithms - the extrapolated possibilities for insight and analysis are almost endless.
US economic data and statistics don't follow S&P 500 sector classifications
And it’s all down to standards. In the world of equities, the GICS is mostly dominant at this point thanks to the S&P 500, but still competes on some level with the Industrial Classification Benchmark (ICB). US economic data, on the other hand, is classified using the North American Industry Classification System (NAICS) or, in the case for trade data, the Standard International Trade Classification (SITC). Fidelity has a synopsis of equity sector classifications in their learning center.
Yearly turnover for the S&P 500 is around 25 companies (about 5% of the total index) with membership changes frequently resulting from mergers and acquisitions or occasionally from negative events that make a company unsuitable for the index (bankruptcy, lack of profitability, falling liquidity, etc). Compared to the Dow Jones Industrial Average this turnover rate is relatively high and results in an ever-changing index of companies that have proven to consistently generate profit. This may be reason enough to explain the difficulties active managers experience in beating the S&P 500 (of course, the argument that active managers are incentivized to maximize assets under management – and hence, management fees – rather than profit is best saved for another day)
As far as ownership is concerned, in the tangled and complex network of financial news, data providers, and stock exchanges, one will often be surprised to see just how small this world really is. The S&P 500 index is owned and operated by S&P Dow Jones Indices (which also, incidentally, owns the Dow Jones indexes), whose majority owner (ie parent company) – following several recent divestitures and name changes – is now called S&P Global Incorporated. A brief history of the S&P 500 is outlined below (Reuters put together a spartan but more thorough event timeline here)
S&P 500 Timeline
1957. S&P 500 is created
1982. Chicago Mercantile Exchange begins trading S&P 500 futures contracts
1999. S&P 500 adopts GICS system developed jointly by Morgan Stanley Capital International (now MSCI) and S&P. This original standard classifies companies into 10 distinct sectors.
2016. GICS creates the Real Estate sector. Real Estate and related companies positioned in this new sector, moving primarily from Finance.
2018. GICS replaces Telecommunications with the new Communication Sector. New sector began trading this last Monday (September 24).
The Communication Services Sector
Internet giants like Alphabet (ie Google) and Facebook have grown larger and larger, branching out into various markets and becoming truly multinational companies. Smaller companies like Netflix and Twitter have also been rapidly expanding. What do these companies have in common? Well, under the old GICS, these companies were all members of the powerful and ever-expanding sector called Technology.
The question soon became whether there was a better way to distinguish between these tech companies and whether some may have outgrown their label. Alphabet, Apple, Facebook, and Microsoft were each fast approaching $1 trillion in market capitalization. At the same time, Telecom was becoming less and less influential as a component of the S&P 500 – recently comprising only about 2% of the index by market cap. After kicking the proverbial can down the road for a bit, the verdict was eventually reached to create a new sector that would group existing Telecom companies with companies who, formerly found residing in the Tech and Discretionary labels, could be re-categorized under a broad new "media company" definition. Thus, the Communication Services Sector was born.
As far as ownership is concerned, in the tangled and complex network of financial news, data providers, and stock exchanges, one will often be surprised to see just how small this world really is. The S&P 500 index is owned and operated by S&P Dow Jones Indices (which also, incidentally, owns the Dow Jones indexes), whose majority owner (ie parent company) – following several recent divestitures and name changes – is now called S&P Global Incorporated. A brief history of the S&P 500 is outlined below (Reuters put together a spartan but more thorough event timeline here)
S&P 500 Timeline
1957. S&P 500 is created
1982. Chicago Mercantile Exchange begins trading S&P 500 futures contracts
1999. S&P 500 adopts GICS system developed jointly by Morgan Stanley Capital International (now MSCI) and S&P. This original standard classifies companies into 10 distinct sectors.
2016. GICS creates the Real Estate sector. Real Estate and related companies positioned in this new sector, moving primarily from Finance.
2018. GICS replaces Telecommunications with the new Communication Sector. New sector began trading this last Monday (September 24).
The Communication Services Sector
Internet giants like Alphabet (ie Google) and Facebook have grown larger and larger, branching out into various markets and becoming truly multinational companies. Smaller companies like Netflix and Twitter have also been rapidly expanding. What do these companies have in common? Well, under the old GICS, these companies were all members of the powerful and ever-expanding sector called Technology.
The question soon became whether there was a better way to distinguish between these tech companies and whether some may have outgrown their label. Alphabet, Apple, Facebook, and Microsoft were each fast approaching $1 trillion in market capitalization. At the same time, Telecom was becoming less and less influential as a component of the S&P 500 – recently comprising only about 2% of the index by market cap. After kicking the proverbial can down the road for a bit, the verdict was eventually reached to create a new sector that would group existing Telecom companies with companies who, formerly found residing in the Tech and Discretionary labels, could be re-categorized under a broad new "media company" definition. Thus, the Communication Services Sector was born.
In-Depth Discussion and Visualization of Communication Sector Effects
Barron’s published a great article in very good detail earlier this month dissecting the composition of the new communication sectors and breaking down the impact from these new changes on existing equity sectors (they have some great informational graphs and heatmaps to help visualize the changes too). You can read all about it here.
The communication sector comprises nearly 10% of the entire S&P 500 and includes internet giants Alphabet (ie Google), Facebook, and their smaller cousin Twitter. Paypal, Electronic Arts, Activision Blizzard were also moved over from Tech while Netflix, Comcast, and the Walt Disney Company joined from Discretionary. For perspective, Communication is now roughly the same size as Discretionary and about half the size of Technology. While Telecom was commonly referred to as a defensive sector, the new Communication sector will be more nuanced, behaving with less sensitivity to interest rates after the addition of numerous growth stocks.
While funds linked to the broader S&P 500 have been unaffected by this move, investors in funds linked to Technology or Discretionary have seen their risk profile modified following the recent exodus and now face the potential for higher volatility going forward (as a result of fewer companies in the sector). This change may benefit individual tech companies and allow them a chance to shine now that they have been able to step out of the shadow of Facebook and Alphabet. Of course, Apple and Microsoft are now the 800-pound gorillas (with Visa as a smaller gorilla, using this analogy) as outsized constituents of the now-smaller technology sector.
In summary, how does this change affect retail investors? Well, unless that retail investor invests in sectors of the S&P 500 for income generation or to gain exposure to specific industries, nothing much has changed. However, the addition of the Communication Services Sector does allow retail investor a new avenue for getting growth without exposure to broader tech names. Technology has become, well, technology. And large internet growth companies (media companies?) are can now be found in their own separate category. Sector picking, rather like stock picking, may be the biggest beneficiary here.
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Following Up and Filling in the Blanks
Trade tensions remain elevated. The good news coming out tonight is that Canada has come to an agreement with the US and Mexico on a replacement for NAFTA. Analysts also expect an eventual trade agreement between the US and the EU, leaving US-China discussions – or lack thereof – as the remaining source of trade uncertainty (Japan doesn't count at this point since tariffs have yet to be implemented). Since The Ignorant Investor’s last post, trade tensions have risen after the US levied tariffs on an additional $200B worth of Chinese goods and China retaliated with duties on $60B of US goods while canceling anticipated high-level trade talks for good measure.
Tesla: What Goes Around Comes Around. That fast-moving SEC probe we were discussing last month? Well, this week we were hit with the news that Elon Musk could lose his position as CEO and Chairman of the board at Tesla after the SEC filed charged him with fraud. Then, just yesterday, we learned that Mr Musk – wisely – decided to settle the charges for what amounts to little more than a slap on the wrist. It’s a win-win situation for investors, who need Musk to continue to oversee Tesla while also providing some more oversight that may help limit what some see as erratic behavior.
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The Ignorant Investor is intrigued about recent changes in oil price forecasts and hopes to soon complete a quick write-up on the topic. This will be coming sometime in the next two weeks!
While funds linked to the broader S&P 500 have been unaffected by this move, investors in funds linked to Technology or Discretionary have seen their risk profile modified following the recent exodus and now face the potential for higher volatility going forward (as a result of fewer companies in the sector). This change may benefit individual tech companies and allow them a chance to shine now that they have been able to step out of the shadow of Facebook and Alphabet. Of course, Apple and Microsoft are now the 800-pound gorillas (with Visa as a smaller gorilla, using this analogy) as outsized constituents of the now-smaller technology sector.
In summary, how does this change affect retail investors? Well, unless that retail investor invests in sectors of the S&P 500 for income generation or to gain exposure to specific industries, nothing much has changed. However, the addition of the Communication Services Sector does allow retail investor a new avenue for getting growth without exposure to broader tech names. Technology has become, well, technology. And large internet growth companies (media companies?) are can now be found in their own separate category. Sector picking, rather like stock picking, may be the biggest beneficiary here.
------------------
Following Up and Filling in the Blanks
Trade tensions remain elevated. The good news coming out tonight is that Canada has come to an agreement with the US and Mexico on a replacement for NAFTA. Analysts also expect an eventual trade agreement between the US and the EU, leaving US-China discussions – or lack thereof – as the remaining source of trade uncertainty (Japan doesn't count at this point since tariffs have yet to be implemented). Since The Ignorant Investor’s last post, trade tensions have risen after the US levied tariffs on an additional $200B worth of Chinese goods and China retaliated with duties on $60B of US goods while canceling anticipated high-level trade talks for good measure.
Tesla: What Goes Around Comes Around. That fast-moving SEC probe we were discussing last month? Well, this week we were hit with the news that Elon Musk could lose his position as CEO and Chairman of the board at Tesla after the SEC filed charged him with fraud. Then, just yesterday, we learned that Mr Musk – wisely – decided to settle the charges for what amounts to little more than a slap on the wrist. It’s a win-win situation for investors, who need Musk to continue to oversee Tesla while also providing some more oversight that may help limit what some see as erratic behavior.
------------------
The Ignorant Investor is intrigued about recent changes in oil price forecasts and hopes to soon complete a quick write-up on the topic. This will be coming sometime in the next two weeks!
