Despite summer’s swoon, tech remains the top-performing global sector this year. That probably doesn’t surprise you. But not far behind is the less-seen, less-understood communication services sector. What is it exactly? Can its hot run last? And where do you find exposure on a global basis? Let me explain.
The MSCI World Communication Services index sings a song of oddly mixed industries – high-growth, tech-adjacent firms and old, stodgy telecoms. For decades, “communications” stocks meant telcos – classically defensive, highly regulated slow-growers. These steady, boring telecoms feature reliable revenues, big dividends and low volatility – rendering them insensitive to economic cycles.
Hence, telecos typically lead when markets fall. Since 2000, global telecoms beat the MSCI World Index in nine of 12 broad market drops exceeding 10 per cent. But good defence, in this case, means bad offence: They lagged in nine of 12 upturns in those same spans. The average underperformance? A whopping 29.6 per cent! When world stocks fell just 7.3 per cent from July 16 to Aug. 5, the global telecom sector fell 2 per cent. In the bounce since, world stocks gained 6.3 per cent. Telecom? A mere 3.5 per cent.
But in 2018, index providers S&P and MSCI meshed several tech-like giants with defensive telecoms, creating the new “communication services” sector. This changed everything.
Boring phone lines yielded to search engines, social media and online commerce. The old telecom industry, folded into the new sector, totals less than one-fifth of its market cap.
Meanwhile, the interactive media and services industry dominates, comprising 60 per cent of the sector. You know the sector’s biggest names: Meta META-Q and Google parent Alphabet GOOGL-Q. But it also includes online dating, recruiting and more – cutting-edge categories with far lower barriers to entry than telecom’s costly wirelines and towers.
Communication services also include the entertainment industry, which is home to big streaming and gaming firms and accounts for 15 per cent of market cap. The other 7 per cent is media – businesses such as cable providers, TV networks and advertisers.
Hence, large swaths of this diverse sector act like tech: they have low dividends, fat gross operating profit margins, big ongoing reinvestment in innovation, buzzy offerings … and huge growth.
These tech-like tendencies juiced returns in up markets – including 2024′s. Consider: interactive media and services is up 31.1 per cent globally this year, driving communication service’s 23.9-per-cent overall return and topping tech’s 29.4 per cent. It trounces world stocks’ overall 18.8-per-cent climb. The sector’s entertainment industry firms are also shining, up 18.4 per cent. Its telecom segments lag a bit more: After a big July and August rally, typically defensive wireless telecom is up 19.1 per cent. Diversified telecom – the stodgiest of the stodgy – lags at 15.3 per cent.
This industry divergence is even more pronounced since this global bull market’s start. Since 2022′s low, communication services has roared 64.8 per cent globally, easily topping world stocks’ 57.7-per-cent gain. Again, within the sector, interactive media and services did great – up 103 per cent, nearly matching tech’s 104.7 per cent. Entertainment also leads beats world markets – slightly, at 58.6 per cent. But the wireless and diversified telecom segments are way behind – up just 32.3 per cent and 12.2 per cent, respectively.
Few envisioned tech-like portions of communication services soaring back in late 2022 – just the opposite, after they lagged on the way down to the bear market bottom. And yet they did. Sentiment overly soured on them. Then, amid the doom and gloom, markets looked forward, foretelling a rebound and boomed. Stocks always preprice economic and corporate realities three to 30 months out.
That prepricing proved prescient. With 88 per cent of its constituents having reported, second-quarter earnings per share in interactive media and services soared 40.1 per cent year-over-year, a second-straight booming quarter that clobbers world stocks’ overall 5.4-per-cent EPS growth.
So, what now? Expect more strength from big, tech-like communications firms. Few notice but, almost every single day that the market is up, they are up more (and vice versa when stocks fall). They should keep thriving as firms switch to offence after two years of cost-cutting. Their fat gross operating profit margins let them self-finance growth easily. Those margins in communication services are 43.9 per cent, led by a juicy 64.6 per cent in interactive media and services – topping tech! The advertising market, which so many of these firms capitalize on, should reheat, too.
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