Tech Stocks Are About To Be Less Risky

Would you buy any fund (active or passive) that had the following stock allocations:

• Alphabet/Google: 25.3%
• Facebook: 18.0%
• Twitter: 2.3%
• Total weighting in all three: 45.6%

The answer would probably be “No” given this week’s Congressional hearings and persistent chatter about future incremental regulation for these three names. Recent price action underlines these concerns.

• Facebook’s stock has traded poorly since Tuesday, breaking through its post Q2-earnings call lows.
• Twitter is down 13% over the last five days.
• Google, excoriated for not even showing up to the DC hearings, is 5.7% lower over the last week.

Well, welcome to the revamped “Communication Services” sector of the S&P 500, which is set to go live on September 21st. That is when Google, Facebook and Twitter all stop being Tech stocks start flying the colors of this new industry group with the weightings we outlined above. Some other important names moving to Comm Services, and their weightings:

• Comcast: 5.2%
• Disney: 4.9%
• Netflix: 4.0%
• CBS: 2.0%

There’s already an ETF for this group (symbol XLC), so it is easy enough to see how this new sector is performing even before its go-live date. No surprise, but the numbers are not good. Communication Services is the worst performing “sector” in the S&P 500 over the last month, down 3.6%. Only Energy (-3.5%) is also lower over the same period, and the S&P itself is +1.0%.

As for the investment implications of all this going forward, 3 points to consider:

#1. By stripping out Facebook, Alphabet/Google and Twitter from “Technology”, the S&P Dow Jones Indices committee has effectively reduced that sector’s near term regulatory risk. Not entirely, of course… Apple and Microsoft remain, for example, and they are large enough for governments to care about their actions/market dominance. But shifting this week’s DC targets to another sector now looks like a pretty smart move on the part of the index committee.

#2. That’s important, because the second largest US equity sector ETF tracks the Technology piece of the S&P 500; XLK has $23 billion in AUM. Once Facebook, Twitter and Alphabet/Google are gone later this month, this fund will look quite different and (perhaps) better to investors wary of tech sector regulatory risk. That could improve money flows into the “new Tech” sector from both ETF and other passive inflows.

#3. We’re all going to have to recalibrate how we measure Tech sector regulatory risk, if only because the current poster children of this concern are no longer “Technology stocks”. By quarantining FB/GOOG/TWTR in Communication Services, the narrative around the Tech sector changes, presumably for the better or at least “Not as bad”.

Summing up: in an investment climate where passive strategies have an ever-larger role in capital allocation, what sector name you hang on a given stock matters. The three most controversial Technology names just now won’t be “Tech” for much longer.