In September 2018, there was a meaningful change to the way many stocks are categorized, potentially impacting anyone who invests in technology and communications stocks.
In what was hailed as one of the biggest changes to stock classifications since the 11-sector system was put into place in 1999, many recognizable tech stocks were officially considered communications companies.
In short, the telecommunications sector was re-named “Communications Services” and now includes some companies formerly from other sectors, including tech. As much as 8.2% of the entire market capitalization of the S&P 500 was impacted by this change.
The sectors outlined by the Global Industry Classification Standards are used by S&P Dow Jones and the MSCI, which publish most of the major stock market indices worldwide.
The Basics of the Change
In short, the changes to classifications can be summarized as follows:
- Telecommunications is now known as Communications Services
- Many information technology stocks will move to the new Communications Services sector
- Some consumer discretionary stocks will also move to Communication Services
- Online marketplaces, such as eBay, will move from information technology to consumer discretionary
There are many reasons for this change, but the main impetus is that the information technology sector was getting very large, suggesting that many stocks deserved to be reclassified. Moreover, some companies, such as Facebook and Google, have evolved to resemble communications firms rather than simply tech firms.
Initial analysis suggested that this change would boost the new Communications Services sector in the S&P 500, while decreasing the presence of information technology. Prior to the change, information technology made up 26.3% of the S&P 500, but after the change it comprised 20.6%, according to Fidelity. Meanwhile, the former telecom sector once comprised 1.9% of the S&P 500, but then made up 10.3%, making it the fourth-largest sector overall.
Historically, if you want to get a sense of how a sector might perform, you can examine past prices. But making such comparisons may now very difficult, as the makeup of sectors will be very different.
A Defensive Sector Becomes More Volatile
The former telecommunications sector was once seen as one of the more stable parts of the stock market because it included many dividend stocks that avoided large swings in stock price. AT&T is perhaps the poster child for this kind of company. In fact, many investors purchased stocks in the telecommunications sector instead of purchasing U.S. Treasury bonds because the stocks offered similar stability and income potential.
But the new communications sector was expected to become more cyclical and more volatile, thanks to the addition of large tech firms like Alphabet and Facebook. In fact, the new sector can no longer be considered a “defensive” sector, but likely has greater sensitivity to the movement of the overall stock market.
Sector-Based Investing Is Still Smart
Despite all these changes, it’s important to note that eight out of the 11 sectors are unchanged moving forward. The overall approach of investing in sectors still makes sense. It’s much easier to invest in sectors of the stock market through things like mutual funds and exchange-traded funds than to buy shares of individual companies. Even with the changes, investing in sectors can provide broad exposure to a wide variety of firms and bring great diversity to your portfolio.
It’s worth noting that the managers of mutual funds and ETFs may very well ignore the new classifications when constructing their portfolios. A fund advertised as being focused on technology can still invest in Netflix or Facebook, for example. Thus, it remains important for all investors to review the holdings of any fund before buying shares.