Big Changes to Big ETFs

Ten days ago, the S&P committee that decides which stocks belongs to what industry groups made the largest changes to these designations in decades.For example, Facebook and Google are no longer “Tech” stocks; they are Communication Services, a new sector. Disney, Netflix and Comcast moved from Consumer Discretionary to that same Comm Services group. We highlighted these moves several times in these notes as they unfolded.

Today we want to briefly update you on two issues:

  • What did asset managers do in the week after these shifts to realign their portfolios?
  • What do the “new” Technology, Consumer Discretionary and Comm Services sectors now hold, and which (if any) are worth overweighting right now?

On the first point:

  • There were actually some dramatic capital reallocations last week among the ETFs affected by these changes, something we have not seen highlighted anywhere.
  • The largest outflows were from XLK (Technology), with $3.8 billion in redemptions last week (14% of its entire asset base). This largest-of-all Tech sector ETF lost exposure to not only Alphabet and Facebook, but also Verizon, AT&T, 3 video game companies and one other Telecomm name.
  • XLY, the largest Consumer Discretionary ETF, saw $2.1 billion of redemptions last week. We noted above that several name band media companies shifted to Communication Services, but there were several others as well.

So where did this $5.9 billion of assets go?

  • $1.0 billion landed in Communication Services, with the ETF symbol “XLC”. This doubled the size of this fund, to $2 billion in assets under management.
  • Some part of this capital also seems to have ended up in the Tech-heavy QQQ product, which saw $1.8 billion of inflows last week. That is just over a third of its YTD money flows, unusual enough to make us think it benefited from investors anxious to retain traditional Tech exposure.
  • Quite a bit seems to have shifted to small caps, with IWM (iShares Russell 2000) seeing $2.9 billion of inflows, essentially all the fresh money it has received the entire year. Yes, it’s strange to replace large cap Tech/Consumer Discretionary with small caps. But the data points in this direction.

On the second point: what do “new” Tech (XLK), Consumer Discretionary (XLY) and Communication Services (XLC) look like now, and what do we like?

#1. All three have notable single name concentration:

  • Tech (XLK) has 51% of its weighting in five names: Apple (20.1%), Microsoft (17.0%), Visa (5.2%), Cisco (4.3%), and Intel (4.2%).
  • Consumer Discretionary has 49% of its weighting in five names: Amazon (23.3%), Home Depot (10.6%), McDonald’s (5.8%), Nike (4.9%), and Booking Holdings (4.2%).
  • Communication Services is the heaviest of all, with 55% in its top five names: Alphabet/Google (23.2%), Facebook (17.5%), Disney (4.8%), EA (4.7%) and Netflix (4.6%).
  • As a point of comparison, consider the Financial Services sector, where the top 5 names (Berkshire, JP Morgan, Bank of America, Wells and Citi) have a 45% collective weight.

#2. All three are heavily skewed to “Growth” stocks:

  • The S&P 500 is 60% weighted to growth
  • Consumer Discretionary is now 84% growth stocks
  • Technology is slightly less, at 82% growth
  • Communication Services is 69% growth

#3. In order of preference, we like “new” Technology the most, Communication Services the least, and Consumer Discretionary in the middle.Here’s why:

  • Communication Services, given its 41% weight in Alphabet and Facebook, has the largest regulatory overhang of the three and significant single stock risk in these names.
  • Consumer Discretionary is a lumpy bet on Amazon (23% weight), home improvement retailers (15% in HD and LOW) and eating out (9% in MCD and Starbucks). That’s 47% of the pie, but current trends to online shopping and consumer spending should favor the group.
  • Technology is, relatively speaking, the most thematically diversified of the three. Apple and Microsoft are 37%, semiconductors are 15%, and payment systems (Visa and Mastercard) are 9%. Not as much overlap/concentration here, we feel, as the first two groups, and good fundamentals for next year.

Data source: www.xtf.com

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