WASHINGTON. It’s options expiration Friday. That popular monthly event traditionally moves stocks every which way as investors exercise call and put options, putting uncommon buy and sell pressure on certain volatile stocks. We often call this “Freaky Friday.” But more importantly, today is also the very big day that both mutual funds and ETFs need to move around mass quantities of some very large and popular stocks. The reason why? To reflect the formal industry sector moves in S&P’s hyper-active IT sector and its moribund Telecommunications sector.
Industry sector investing and the GICS
Confused? We’ve dealt with this incoming and important shift in a previous column. But it’s all pretty simple if you’re a regular investor in ETFs based on widely-followed industry sector indexes.
S&P, via its Global Industry Classification Standard (GICS), long divided the universe of stocks into ten distinct industry sectors, such as Financials, Consumer Discretionary, etc. Professional and institutional investors have long followed one or more industry sectors, sometimes per quarter, identifying them as attractive places to do stock picking. Based, of course, on where the economy is going at any given time. As one result, the investment industry responded by creating well-defined industry sectors containing a large number of representative stocks.
Over time, the industry also created indexes of these stocks, weighted in favor of large cap stocks, so investors could actually see on a daily basis, where various sectors were going. This enabled them to adjust their portfolios over time to remain primarily in the hottest sectors, presumably increasing their returns.
The rise of the ETFs
A number of years ago, these investment sectors formed the basis for mutual funds that tracked these indexes. Later, the industry created the first of today’s generation of ETFs – essentially mutual funds that trade all day, like stocks – to reflect these indexes. Hence, the term, “Index Funds.”
Today, in addition to the GICS standards, there are a lot more niche indexes and a lot more companies that create new indexes. Naturally, there are also a lot more ETFs that follow them. But the big indexes created for the most part by S&P and Dow Jones, are still constructed to reflect the daily moves of the original 10 S&P sectors. I mean 11. That’s because things change. Let me explain.
Things change, and so does each industry sector
Several years back, the green-shades at S&P realized that due to changes in various markets, a few of their original sectors were no longer particularly representative of what was actually going on in the real life business world. S&P realized they needed to re-thinkwhat each industry sector should include, or whether they should add a new sector or two.
A new industry sector for Real Estate
The first major move in this direction evolved a few years back. For years, S&P lumped all REITs — Real Estate Investment Trusts — into the “Financials” sector. There, they joined with banks, insurance companies, etc. That’s because many of these REITs were essentially mortgage REITs. Their main business was raising and loaning money for business or real estate ventures like banks, not actually buying, managing and then selling property.
But as real estate suddenly became an important, recognized “industry sector” during the consciousness-raising years of the Great Recession, S&P finally perceived this industry’s vast size. And so did the investment industry, which for years had never included real estate as much of a concern in their world, which focused on stocks, not tangible things like property.
To enter into that business, at least in a way, S&P and others made an interesting observation. A certain subset of REITs, some quite large, do, in fact, own, manage and lease their own suites of properties. They invest directly in real estate itself, rather than in the financials surrounding this industry. So S&P decided to establish a new industry sector, “Real Estate,” to “house” these stocks. That finally provided a real estate investment sector and index for investors. And eventually for those mutual fund and ETF companies wishing to create new vehicles to track the new Real Estate index.
Adding the 11th GICS industry sector
Hence, S&P split “real estate ownership” REITs out of the financial category to form a new, eleventh industry sector for “Real Estate.”
That gave us the following official industry sectors:
- Consumer discretionary
- Consumer staples
- Information Technology (IT)
- Real Estate
- Telecommunications (but see updated info below)
Another big change is happening, this one to a neglected GICS industry sector
This year, based on continuing industry sector research, S&P has rethought a different pair of its longer-standing sectors, IT and Telecommunications. Due to its rapidly increasing economic importance, they concluded the IT sector had become too huge and unwieldy. Worse, it was far too overweighted in investment portfolios due to the monstrous size of companies like Google (symbols: GOOG and GOOGL) Apple (AAPL) and Microsoft (MSFT).
The Telecommunications sector had the opposite problem. It was languishing because it was essentially down to just three major stocks that didn’t particularly excite investors: AT&T (symbol: T), Verizon (VZ) and CenturyLink (CTL).
Conceptually, the solution was relatively simple: Add a batch of key tech stocks to the Telecommunications sector by pulling them out of IT and moving them into Telecommunications. Which then gets a new name.
Industry sector revisions in a nutshell
ETF Trends provides a convenient, bulleted roadmap of what’s going on and what to expect:
- Last November, MSCI and S&P Dow Jones announced major changes to their sector classification system (GICS), which is used in many popular sector Exchange Traded Funds.
- The broadening of the current Telecommunications sector (to be renamed the Communications [Services] sector) significantly alters the Information Technology and Consumer Discretionary sectors.
- Most of the affected S&P benchmarked sector ETFs are scheduled to rebalance Friday September 21st at the close.
- Communications Services (formally Telecommunications), will increase from roughly 2% to 10% of the S&P 500.
Technology will be reduced from approximately 26% to 20% of the S&P 500.
- Consumer Discretionary will be reduced from approximately 13% to 10% of the S&P 500.
- In advance of these changes, Sector SPDRs introduced XLC, the Communication Services Sector SPDR, this summer. On Sept. 21, 2018, the Technology (XLK) and Consumer Discretionary (XLY) Sector SPDRs will rebalance to reflect the GICS changes.
- FAANG representation will be spread across all three Select Sector ETFs: XLK, XLY, XLC
- Facebook and Google are leaving Tech and joining Communication Services
- Netflix is leaving Discretionary and joining Communication Services
- Apple is remaining in Tech
- Amazon is remaining in Consumer Discretionary and increasing to roughly 25% of the index
What ETF traders and investors can expect next week
An ETF Trends recap explains the further significance of these moves.
“The extended bull market fueled by expansive growth in the technology sector may have been the catalyst for change as the reclassification of the sector takes place today, which could mean a bout of volatility is looming at the opening of Monday’s trading session. The S&P Dow Jones Indices will be reorganizing the Global Industry Classification Standard (GICS), which will bring a bevy of changes in not only tech, but also communications.
“As technology, consumer and media industries have evolved since the dot-com bubble, so have the companies within those respective sectors. As such, this new reclassification reflects those changes.
“‘The changes are a step toward acknowledging the convergence of telecommunications, media, and select internet companies and the overlapping services rendered by these companies, within the GICS Structure,’ S&P noted.”
Big changes may spring from S&Ps big GICS industry sector moves
All in all, this massive chessboard move is effecting a major transformation on S&P’s widely followed industry sector groupings and indexes. It will also affect a great many popular corresponding ETFs and mutual funds as well. One CNBC report Friday sums up that side of the equation.
“After the bell Friday, around $2.8 trillion in equities will be reshuffled into the newly created communications services sector.
“Those changes will leave the tech sector looking a little different to investors.
“‘What’s going to be left of the technology sector is going to be largely driven by the hardware and the software and services space,’ explained Lindsey Bell, investment strategist at CFRA Research [the new name for the former S&P research team], on CNBC’s ‘Trading Nation’ on Thursday.
“Among the biggest changes, Facebook and Google parent Alphabetwill move out of tech into the new sector. Apple‘s leadership will expand to a 21 percent weighting, up from 17 percent, while Microsoft will place second with a 17 percent weighting from 13 percent.
“Apple and Microsoft as the two biggest drivers should continue to lead gains in the tech sector after the move, says Bell.
What to expect in Monday trading action
ETFs accomplished most of the sector shuffling on Friday. So all investors involved in these and other sectors should get ready for what could be a volatile trading day next Monday. At least some investors will awaken wide-eyed to find their ETFs and underlying sector indexes have changed considerably. There could be substantial moves up or down.
But, orderly or chaotic, if you didn’t feel the effects of this “big switch” on this month’s Freaky Friday, you probably will at Monday’s opening bell. And things should settle back down over the next few trading days as investors — and ETFs — adjust to these new but welcome industry sector adjustments.