Tech may be the top-performing global stock sector this year, but there’s another sector that’s not far behind – Communication Services. This sector, which is barely six years old, combines growthy, tech-like firms with traditional media and telecom companies. It’s a tale of diverging industries coming together.
The predecessor to Communication Services was the telecom sector, which was known for being defensive, highly regulated, and slow-growing. These telecom companies were economically insensitive, with steady revenues, big dividends, and low volatility. In fact, telecom stocks outperformed the broader market in four out of five bear markets since 1990. The exception was during the dot-com bubble when companies like WorldCom and Lucent collapsed.
However, telecom companies have lagged behind in bull markets. In the past five bull markets, they underperformed by an average of 128%. Since the low point in October 2022, telecom returns have been less than half of the broader market’s gain.
In 2018, index providers S&P and MSCI made some changes that shook up the sector. They reclassified several Silicon Valley giants as Communication Services companies instead of tech companies. These companies were profiting more from ads than from hardware and software. This led to the creation of the Communication Services sector, which combines tech giants, media companies, and telecoms.
Communication Services is no longer just about phone lines. It now includes search engines, social media platforms, streaming services, and online commerce. The old telecom industry only makes up 17% of the sector’s market cap globally. Meanwhile, the Interactive Media & Services industry dominates the sector with a 62% market cap globally. Most of this industry is American, including big names like Meta and Google parent Alphabet. It also includes online recruiting and web-based auto selling and buying firms.
The entertainment industry makes up 15% of the Communication Services sector’s market cap. This includes streaming and gaming companies, which have tech-like characteristics. The remaining 7% is media, including cable providers, TV networks, and advertisers.
Many parts of the Communication Services sector act like tech companies, with low dividends, low barriers to entry, high profit margins, and a focus on innovation. These tendencies have fueled the sector’s growth in bull markets, including the current one. The MSCI World Communication Services index has returned 19.3%, outperforming tech’s 25.5% and world stocks’ overall return of 11.4%.
However, not all segments of the sector have performed equally well. While Interactive Media & Services and entertainment firms have seen strong returns, telecom segments like wireless and diversified telecoms have lagged behind. This trend has been consistent since the bull market began in October 2022.
Looking ahead, Communication Services could continue to lead in the current bull market. The tech-like chunk of the sector is expected to shine as companies shift from defense to offense and focus on growth. These companies have high profit margins that enable self-financing of growth, making interest rates less impactful. Additionally, the advertising market, which is central to many Communication Services firms, is expected to heat up.
In conclusion, investors should consider diversifying across offensive industries like Communication Services while going light on defensive ones. This sector offers a unique combination of tech-like growth potential with elements of traditional media and telecom. As corporations shift to offense and the advertising market heats up, Communication Services could continue to outperform in the current bull market.
Ken Fisher is the founder and executive chairman of Fisher Investments, a bestselling author, and a regular columnist in multiple countries globally.
