Bob’s Journal
Investors soon will be reminded that index investing isn’t the same as passive investing.
Standard & Poor’s and MSCI, the leading constructors of market indexes, will be overhauling their indexes. This isn’t the typical periodic change in which they move a few stocks in and out of the indexes.
Instead, the firms are overhauling the way they divide the market indexes into sectors and classify firms in each sector. The changes will take place after the Sept. 28 close for S&P and on Dec. 3 for MSCI.
The biggest move is that the telecommunications sector will disappear, to be replaced by communications, which will be the fourth largest in the S&P 500. The S&P 500 still will have 11 sectors. In the overhaul, hundreds of stocks will be reclassified and the compositions of major sectors will change.
Facebook (FB) and Alphabet/Google (GOOGL) will leave the technology sector and dominate the new communications sector. Together, they will be almost 50% of the sector, based on recent stock prices.
Technology has been the leading market performer for a while and now is more than 26% of the S&P 500. It has generated more than half the index’s gains in 2018. Joining Facebook and Alphabet/Google in the move from technology to communications will be Activision Blizzard (ATVI), Electronic Arts (EA), Twitter (TWTR) and Take-Two Interactive Software (TTWO).
The moves greatly reduce the size of the tech sector and shift its focus to hardware, software and microchip makers. Leading firms in the sector will include Apple (APPL), Microsoft (MSFT) and Intel (INTC). In other words, it will be more of an “old tech” sector, but Apple will dominate it, taking 20% of the total sector.
About half the capitalization of the communications sector will come from the old tech sector. Those stocks will be combined with media and telecommunications companies, including CBS (CBS), Comcast (CMCSA), Netflix (NFLX), AT&T (T) and Verizon (VZ).
The consumer discretionary sector also will be a bit different. It is dominated by Amazon (AMZN) now and still will be after the changes. But Amazon’s share will increase from 27.7% to 35.0%. Media firms will leave the sector and join communications, while eBay (EBAY) and a few other firms will be added to consumer discretionary.
These and other changes won’t matter much to investors in broad index funds. But investors in sector funds will have to re-evaluate their choices, whether the funds are actively managed or index funds. Either way, the fund will be compared to an index and make portfolio changes based on changes in the index.
Exchange-traded fund (ETF) managers and others already are acting in advance of the official change. AT&T and Verizon returned over 5% in the last month, which many analysts attribute to managers buying more of the stocks in advance of the official sector changes.
The changes could put more of a floor under stocks such as T and VZ. As part of a larger and more diverse sector that’s had higher returns the last few years, more sector index investors might be forced to buy the stocks.
Firms with sector ETFs have different plans for changing their portfolios. State Street plans to rebalance most of its ETFs after the Sept. 21 market close but already started its communications sector fund in June. Vanguard has been steadily changing holdings. Fidelity will be slower to change.
Investors who own or trade in sector funds need to examine how the funds they use plan to respond to these changes and how the risk and return profiles of the funds will change.
The Data
Manufacturing surged in the last month, according to the ISM Manufacturing Index. The index came in at 61.3, compared to 58.1 last month. The latest number is the highest in 14 years. New orders were the strongest part of the index, but respondents to the survey are worried about rising raw material costs and negative effects from tariffs.
The PMI Manufacturing Index was strong but not as robust. The index declined to 54.7 from 55.3. That’s the lowest level since November. But business confidence hit a three-month high, and the survey revealed increases in output and new orders.
Factory Orders declined 0.8% following a revised 0.6% increase last month. A decline was expected due to a dip in volatile aircraft orders. But excluding transportation, orders increased 0.4%, following a 0.4% jump last month. Orders excluding transportation are up 8.0% over 12 months.
The non-manufacturing sector also seems to be doing well. The ISM Non-Manufacturing Index increased to 58.5 from 55.7.
Consumer Confidence, as measured by the University of Michigan, increased to 96.2 from 95.3 in the mid-month flash reading. That exceeded expectations but still is well below the recent peak in March of 101.4. Even so, high percentages of consumers says this is a good time to buy things because prosperous times are ahead, and they expect incomes to increase in the next year.
The revised productivity numbers for the second quarter were positive. Output per hour increased by 2.9% and total output increased 5.0%. Productivity increased at a 1.3% annualized rate for the quarter. Hourly compensation increased only 1.9%, so unit labor costs declined 1.0%. Productivity has increased 1.0% or better for seven consecutive quarters, which is the longest streak since 2010.
The ADP Private Payrolls report said 163,000 new private sector jobs were created in the last month. That’s a healthy number but less than expectations.
New unemployment claims declined 10,000 to 203,000. The weekly number and four-week average are the lowest since December 1969. The numbers might be revised next week because several states had to estimate their results.
The Markets
The S&P 500 declined 0.84% for the week ended with Wednesday’s close. The Dow Jones Industrial Average fell 0.54%. The Russell 2000 lost 0.41%. The All-Country World Index slid 2.25%. Emerging market equities dropped 5.40%.
Long-term treasuries lost 0.86% for the week. Investment-grade bonds fell 0.30%. Treasury Inflation-Protected Securities (TIPS) declined 0.26%. High-yield bonds gave up 0.27%.
On the currency front, the U.S. dollar rose 0.60%.
Energy-based commodities fell 1.15% for the week. Broader-based commodities dropped 1.55%. Gold lost 0.78%.
Bob’s News & Updates
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