With AI hype sweeping the stock market, you could probably guess that the technology sector will be the best-performing global equity sector this year. And you’d be right. But which sector is trailing just a little behind?
Call, text, email or otherwise message your broker. This is a funny index of what is called a “communication service” and is only six years old.
Never heard of it? You’re not alone. So what is it and does it have staying power?
Communications services is a story of industry bifurcation, blending growing tech companies with traditional media and old-fashioned telecommunications companies.
Its predecessor was the telecommunications sector, which is typically defensive, highly regulated, boring, slow-growing, and completely uninterested in the economy with stable earnings, high dividends, and low volatility.
So these stocks lead the way in down markets. Consider this: Communications stocks in the S&P 500 have outperformed the broader index in four of the five bear markets since 1990. The exception was 2000-2002, when dream stocks like WorldCom, Global Crossing and Lucent collapsed spectacularly.
But rigidity is a double-edged sword. Communications stocks have badly lagged in four of the past five bull markets. The average performance? A whopping 128%. Since their October 2022 lows, the S&P 500 and World Telecom have returned less than half the gains of the broader indexes.
But in 2018, index providers S&P and MSCI made a recalibration, perhaps somewhat quietly, that shook up the way investors approach many of these companies.
So, some of the biggest companies in Silicon Valley decided they weren’t even in the tech industry anymore — they were 21st century communications companies that made their money from advertising rather than hardware or software. Their solution?
It will combine several large technology companies, media companies and defense communications firms to create a new “communications services” division.
Communications is no longer just about telephone lines, wired or wireless. It also includes search engines, social media, streaming, and online commerce. The traditional communications industry now accounts for just 17% of the new sector’s market capitalization, and even less in the US.
Meanwhile, the Interactive Media & Services industry dominates the global market with 62% of the market share, and almost all of it, 99%, is American. You may recognize big names like Meta and Google’s parent company, Alphabet.
But it also includes online hiring, web-based car buying and selling companies, and more.
Communications services also includes the entertainment industry, which makes up 15% of market cap and is home to the major streaming and gaming companies (also tech!), while the remaining 7% is media, which includes cable providers, TV networks, and advertisers.
So much of this diverse sector behaves like technology companies: low to no dividends, low barriers to entry, gross operating margins (GOPM in accounting terms), heavy reinvestment in innovation, buzzworthy services, and big growth.
These tech-like trends will drive returns in bull markets, including in 2024. That led MSCI World Communication Services to a 19.3% overall return, led by a 29.9% surge in Interactive Media & Services stocks, beating the 25.5% return of tech stocks and well ahead of the 11.4% return of global stocks overall.
Entertainment companies in the sector are also up 14.1%. However, the communications sector has struggled, with wireless and diversified communications up just 7.9% and 2.2%, respectively. All of the parallel trends date back to October 2022, when this bull market began.
Few saw this coming after tech and communications services stocks were hit so hard in 2022. But sentiment has escalated too much, and the market is looking ahead to a brighter reality, spurring the rally.
Stocks had been pricing in a 46.3% rebound in the sector’s first-quarter profits.
So will communication services continue to lead? Yes and no. Communications will not lead until the next recession. As the bull market progresses, the tech-related parts of the sector should shine as companies go on the offensive after two years of defensive cost-cutting. Their enviable GOPMs (see above) make growth self-financing and interest neutral. The advertising market, central to many of these companies, should also reinvigorate.
Bottom line: Diversify into offensive industries. Stay away from defensive industries.
Ken Fisher is founder and chairman of Fisher Investments, a four-time New York Times bestselling author and writer of regular columns in 21 countries around the world.
