S&P 500 Communication Services Sector Outperforms: Here's Why

Wall Street has performed exceptionally well so far in 2019 and the momentum is likely to prevail in the last month. Year to date, the three major stock indexes — the Dow, the S&P 500 and the Nasdaq Composite — have rallied 19.6%, 25.1% and 29.9%, respectively. It is worth mentioning that all the three indexes had a pathetic 2018, plummeting 5.6%, 6.2% and 3.9%, respectively.

Notably, a cross-sectional view of the S&P 500 Index — popularly known as market’s benchmark index — will give us an interesting insight.

Communication Services Sector Outperforms

Out of the11 broad sectors of the S&P 500 Index, the Communication Services Select Sector SPDR (XLC) has gained a little more than 27.3% so far in 2019. Year to date, this sector is the second-best performer of the broad-market index after Technology Select Sector SPDR (XLK), which has gained 40.9% so far.

In financial literature, communication service operators are generally characterized as defensive stocks and highly suitable for value investors due to its high dividend yield. These stocks provide above-market returns during a market downturn. However, it is surprising to see this sector outperforming the broader market this year amid a prolonged rally. What made this happen?

Answer Lies in Sectoral Overhaul of S&P 500

The answer to this interesting reversal lies in the sectoral overhaul of the S&P 500 Index conducted by the Global Industry Classification Standard of S&P Dow Jones Indices. Sectoral reorganization became effective from Sep 24, 2018.

The newly formed communication services sector, which replaced the old-economy telecommunications sector, had been reorganized to consist of traditional telecom operators, Internet-based companies and media companies.

Notable Internet-based behemoths and media giants that entered into the communication services field include Facebook Inc. (NASDAQ:FB) , Alphabet Inc. (NASDAQ:GOOGL) , Netflix Inc. (NASDAQ:NFLX) , Comcast Inc. (NASDAQ:CMCSA) and The Walt Disney Co. (NYSE:DIS) .

These stocks have joined existing players like Verizon Communications Inc. (NYSE:VZ) , AT&T Inc. (NYSE:T) , T-Mobile US Inc. (NYSE:T) and CenturyLink Inc. (NYSE:T) . Verizon carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The newly formed communication services sector is cyclical in nature with high growth orientation and low dividend yield. Moreover, within this sector, stocks like Alphabet, Netflix and Facebook carry more weight sidetracking incumbent Verizon and AT&T.

Impact on Stock Markets

Per the index committee of S&P Dow Jones Indices, rapid technological advancement necessitated a sectoral overhaul to reflect consumer preference to utilize Internet services, online digital platform and content as a single entity. The reshuffling of the S&P 500 sectors has made this sector more pure-play in nature.

The chart below shows year-to-date price performance of major newly entered stocks in the communication services sector:

The chart below shows the year-to-date price performance of major incumbent stocks in the connunication services sector:

Comparison of the two charts given above shows that except Netflix, most of the newly entered Internet-based and media stocks have outperformed the S&P 500 Index so far this year. However, among the traditional telecom operators, only AT&T has surpassed the market’s benchmark. Therefore, the characteristic transformation of the newly formed communication services sector has helped it to outperform the broader market.

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