There’s a somewhat unprecedented shake-up taking place within institutional investment portfolios this summer; individual investors need to learn about it so that they don’t get left in the dust, explains Crista Huff, editor of Cabot Undervalued Stocks Advisor.
On June 5, it was announced that a reorganization of the Global Industry Classification Standard (GICS) will take place between now and September 28. GICS classifies stocks into 11 sectors and dozens of industries and is commonly used by professional portfolio managers as a guideline to portfolio diversity. It’s also used to identify stocks that can be included in sector funds (mutual funds and ETFs).
Be ready to read this a few times, because this GICS reorganization is going to cause stock volatility and provide opportunities for several months.
Newscasters who don’t know the cause of the volatility will try to connect it to the political news du jour and yell “Italian debt!” and “tariffs!” and “North Korea!” That’s not going to help you invest well. So let’s nail down some of the intricacies of what’s about to take place.
The telecommunications services sector will be renamed communications services.
Importantly, Alphabet (
Therefore, many portfolio managers of information technology sector funds will be required to sell their GOOGL and FB shares, because those shares will no longer fit their investment strategies. The selling activity will push the share prices down.
For example, the iShares Global Technology ETF (
In addition, Walt Disney (
Portfolio managers of communications services funds will likely add CMCSA, DIS, FB, GOOG, GOOGL and NFLX to their funds. Here’s the important detail: there are far more information technology sector funds than there are communications services sector funds.
Therefore, the total amount of selling activity among CMCSA, DIS, FB, GOOG, GOOGL and NFLX will not be offset by an equal amount of buying among sector funds. The imbalance could cause the share prices to drop and remain low for several months.
While the telecommunications services sector currently makes up less than 2% of the S&P 500, the new communications services sector will comprise 10% of the S&P 500.
Now imagine that you are the portfolio manager of the iShares Global Telecom ETF (
But now you’re required to spread that $350 million to cover many more stocks that are joining the sector. The only way you can do that is by selling portions of your current holdings—the top holdings in IXP are AT&T (
That’s going to push share prices down on all of the pre-existing communications services stocks that you sell. Individual investors who own the original stocks within the communications services sector will need to be prepared to experience a possible downturn in their share prices.
It isn’t just mutual funds and ETFs that will need to readjust their portfolios. Most large institutional portfolios, such as pension funds, also allocate capital across sectors in order to maintain diversification and lower overall portfolio risk.
These portfolios will be doing much of the aforementioned buying and selling of famous stocks, with a twist. As they reexamine their sector holdings in light of the new category components, they’re occasionally going to find themselves overweight a certain sector.
If they’re overweight in communications services, for instance, they’re going to decide which stocks to keep and which to sell. Given a choice between selling TWO of the following stocks, which would you sell: AT&T, DIS, CMCSA, FB, GOOG, GOOGL, NFLX and VZ?
I don’t necessarily mean to imply that T and VZ are bad stocks, but suddenly they’ll be competing for portfolio attention with far more glamorous companies. So there’s going to be ongoing selling pressure for the next four months as literally every professional investor in the U.S. readjusts their portfolios. Wow.
But wait, there’s more. When portfolio managers remove FB, GOOG and GOOGL from their technology sector allocations, they’re going to free up room within their technology sector weighting to add more technology stocks.
Whoa. We’re talking about software and hardware and semiconductors and more. Which are your favorites? Apple (
If you are concerned that you own a stock that might see its price decline in the coming months, there are at least four things you can do:
• You can hold the stock and consider buying more shares if the price becomes depressed.
• You can sell the stock now, with the intention of repurchasing the shares if a lower price presents itself.
• You can hold the stock and use stop-loss orders to protect your downside.
• You can consider using equity options strategies to protect yourself and/or to capitalize on the volatility.
Here’s some important information from MSCI.com: “MSCI will provide the full list of all companies affected by 2018 GICS changes on July 2, 2018. Updates to the list will be provided on August 1, 2018 and September 3, 2018. MSCI will make available a series of provisional indexes for the Communications Services, Information Technology and Consumer Discretionary Services Sectors starting July 2018.”
As portfolio managers shuffle stocks within the communications services sector, one of the first stocks to go from growth portfolios will likely be AT&T or Verizon.
AT&T is projected to see earnings per share (EPS) grow just 1% in 2019. The 6.1% dividend yield will cause some portfolio managers to hold the stock, but growth managers need to deliver capital appreciation, which is unreasonable to expect from a company with stagnant profits.
Verizon is no better, with 2% expected 2019 EPS growth and a 5.0% dividend yield. Lots of portfolio managers are going to dump at least one of these two lumbering blue-chips, and here are the potential deciding factors: Verizon’s long-term debt-to-capitalization ratio is 66% whereas AT&T’s is 43%. Debt really strangles a company’s ability to function well.
However, AT&T is in the process of purchasing Time Warner, a company that’s also expected to see pathetic EPS growth of less than 1% in 2019. Talk about a lackluster merger! In addition, the merger will increase AT&T’s debt levels, so the company loses that balance sheet advantage over Verizon within institutional portfolio decisions. Now we’re back to a 50/50 comparison between the two companies!
When big companies like AT&T and Time Warner merge, the new stock tends to stagnate for almost exactly nine months after the close of the deal. At that point, if financial targets are being met and profits are projected to grow nicely — maybe 10% to 20% in the coming year — only then does the stock begin to rise.
As a growth & value investor, I see no reason to own either AT&T or Verizon shares, because they’re not delivering any earnings growth to speak of, yet institutional portfolio managers are unlikely to sell both stocks. They have investment committees to report to.
They can’t just sell both AT&T and Verizon without doing some pretty fancy explaining, so they’re going to keep the one that’s easier to justify.
My guess is that they’ll keep AT&T shares due to the general excitement over the Time Warner merger. It’s going to be easy to convince Chief Investment Officers that the big merger AT&T-Time Warner could turn out well, thereby postponing a difficult sell decision, and taking the easy way out by selling Verizon.
So, what will they buy to fill in the communications services sector of their portfolios? Given a choice between Alphabet and Facebook, each coming in from the technology sector, I’d choose Facebook in a heartbeat. Here’s why: Alphabet’s earnings growth is slowing dramatically, expected to be just 7.3% in 2019, and the corresponding P/E is very high in comparison at 24.3.
Facebook is expected to see EPS grow 19.1% in 2019, and the corresponding P/E is quite fair in comparison at 21.1. Whether you’re a growth manager or a value manager, it will be an easy choice to reach for Facebook over Alphabet when your goal is capital appreciation. If you are a growth investor, it could be wise to follow suit, and if you’re a growth & value investor, you might want to skip both of those stocks in favor of Apple.
I’ve already mentioned that Apple will see increased buying within the technology sector, and deservedly so. Apple presents both tremendous value and attractive earnings growth. Wall Street’s consensus earnings estimates project Apple to see 2019 profits grow 15.3%, and the corresponding P/E is 14.4. Adding to the value side of the equation are the 1.5% dividend yield and the recently announced $100 billion share repurchase plan.
There’s a lot less fear that your share price can decline when you know in advance that the company is going to swoop in and buy lots of its stock every single time the stock market goes through a rough patch! What’s more, Apple’s stock is just beginning to reach new highs. For investors who want capital appreciation sooner rather than later, that’s the most bullish time to own a stock.
Of all the stocks mentioned in this article, the one I favor, far and away above all others, is Apple. I’ve been investing in stocks for 30 years, and I advise thousands of investors on selecting high quality portfolio stocks and eliminating as many risk factors as is reasonably possible. There’s only one stock that I would be willing to put my name behind and call it a forever stock, and that’s Apple.
Crista Huff is editor of Cabot Undervalued Stocks Advisor.
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