• Technology may be lower octane. Some of the digital advertising and social media stocks that are leaving the technology sector are high-fliers. Losing these historically faster growing technology leaders may dampen the growth prospects for the technology sector, but it also slightly reduces valuations. The five technology companies leaving the sector have an average consensus long-term growth rate of 17 percent, compared with 14 percent for the sector overall. But those stocks carry an average PE of 29, compared with 19 for the sector (FactSet data). Also keep in mind the smaller technology sector will be more concentrated in its largest holding: Apple.
• Potentially more demand for traditional telecom names. The traditional telecommunication services sector had been whittled down to just three stocks after years of consolidation and business model disruption. As a result, the sector drew little interest among sector investors. In fact, most sector strategies were unable to replicate the sector due to rules around concentrated investment products. The revamped communication services sector has become much more attractive to investors, in our view; this may lead to more demand for products tracking the sector and, therefore, some incremental buying in traditional telecom stocks.
These are meaningful changes. Peter Lynch, the famed portfolio manager, once said about stock portfolios, “Know what you own.” That advice holds here. For those who own telecom strategies in particular, but also those who use or are considering using consumer discretionary or technology sector strategies such as ETFs, these changes are important to keep in mind.
Conclusion
Nearly 10 percent of the S&P 500 will see a change in sector classifications on September 28, the biggest impact on the sector landscape in the history of the GICS sectors going back to the 1990s. While a company’s reclassification may not impact the holder of that particular stock, or its growth or return prospects, the change matters for those using sector equity strategies.
The revamped and rebranded telecom sector—to communication services—will look much different than its predecessor, with superior growth prospects and higher valuations, but also higher volatility. It will no longer be one of the so-called defensive sectors. At the same time, the consumer discretionary sector will have less emphasis on traditional media, while the technology sector will lose some of its Internet high-fliers and see its weight in the S&P 500 drop quite a bit. We believe these changes are important for investors to consider.
John Lynch is chief investment strategist at LPL Financial. Jeffrey Buchbinder, CFA, is an equity strategist at LPL Financial.