Communication Services, a formerly stodgy sector, is now rivalling Tech

WHAT is 2024’s top-performing global sector? With AI hype and hope dominating, you know it is Tech. But right behind, clobbering all else, is less-seen and little-known Communication Services.

While present in Singapore, it is largely absent from the Straits Times Index (STI) – partly explaining the index’s 9.2 per cent year-to-date return through Jul 29, lagging global stocks’ 14.4 per cent.

So what is this sector? And can its hot run last? Yes… and no.

Communication Services’ odd mix of Tech-adjacent firms – which have some growth potential – and old, stodgy telecommunications players tells a tale of diverging industries. Let me explain.

For decades, “communications” stocks meant just Telecom – classically defensive, highly regulated slow-growers. Big! Steady! Boring! Think Singtel – its recent data centre investment buzz notwithstanding.

Globally, Telecoms feature steady revenues, big dividends and low volatility – rendering them economically insensitive.

Hence, since 2000, Telecoms led world stocks in eight of nine broad market drops exceeding minus 10 per cent (excluding dividends). But good defense meant bad offense: Telecoms lagged in all nine upturns. The average underperformance? A whopping 30 percentage point difference!

Since 2022’s low, Telecoms delivered just 21.4 per cent including dividends while world stocks soared 44 per cent. Huge lag!

But in 2018, index providers S&P and MSCI meshed various 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 – spurring Tech-like growth. The old Telecom industry remains, but it is just over one-sixth of the new sector’s market cap.

Meanwhile, the Interactive Media & Services industry dominates, comprising 60 per cent of the sector. It is nearly all American – almost 99 per cent; none is Singaporean.

You know its big names: Meta and Google parent Alphabet. 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 includes entertainment stocks – big streaming and gaming firms – which make up 14 per cent of the sector’s market cap.

Think Singapore-based Garena parent, Sea – Tech-like, too. The other 7 per cent is media – cable providers, TV networks and advertisers.

Hence, large swaths of this diverse sector act like tech: low dividends, fat gross operating profit margins (GOPM), big reinvestment in innovation, buzzy offerings… and huge growth.

These Tech-like tendencies juiced returns in up markets – including so far in 2024.

Consider: Interactive Media & Services is up 25.9 per cent globally year to date, driving Communication Services’ 18.9 per cent overall return and topping Tech’s 22.6 per cent. It trounces world stocks’ overall 14.4 per cent climb. The sector’s Entertainment industry firms are close to that world average, up 12.8 per cent.

Its Telecom segments lag a bit more: Wireless Telecom has risen 11.9 per cent while Diversified Telecom – the stodgiest of the stodgy – is up just 10.2 per cent.

This industry divergence is even more pronounced since the start of this global bull market.

Since 2022’s low, Communication Services has roared 61.7 per cent globally, easily topping world stocks’ 44 per cent gain. Again, Interactive Media & Services was the biggest winner – rising 99.4 per cent, beating even Tech’s 86.4 per cent.

Entertainment lags slightly, at 37.6 per cent. But Wireless and Diversified Telecom are way behind – rising just 22.1 per cent and 21.3 per cent, respectively.

Few envisaged Tech-like parts of Communication Services soaring back in late 2022 – just the opposite, after their painful lag on their fall to the bear market bottom. But they did.

Sentiment got too sour towards their outlook. Amid the doom and gloom, markets looked forward, foretelling a rebound. They always pre-price economic and corporate realities three to 30 months out.

That pre-pricing proved prescient. Interactive Media & Services’ first-quarter earnings per share (EPS) soared 31 per cent year on year, clobbering world stocks’ overall 3.1 per cent EPS growth. World Communication Services’ EPS grew even more, at 46.2 per cent year on year.

So what now? Expect more strength from big, Tech-like communications firms.

They should continue thriving as corporations switch to offence after two years of cost cutting. Their fat GOPMs let them self-finance growth as spirits warm. The advertising market, which so many of these firms capitalise on, should reheat, too.

Consider: Communication Services’ GOPM is 44 per cent, easily topping world stocks’ overall 31 per cent. It finances their growth. The fattest reside in Interactive Media & Services, boasting mammoth 64 per cent GOPM. That tops even Tech’s 50 per cent.

That is where the leaders should be.

Singapore has some, though the biggie – Sea – trades in the US and hence doesn’t help the STI.

So, shop America for the biggest, juiciest global Interactive Media & Services opportunities. Diversify your domestic Entertainment holdings with US, Japanese and Dutch firms, too.

Then, watch as these Tech-like stocks drive this bull market higher in 2024.

The writer is the founder, executive chairman and co-chief investment officer of Fisher Investments, an independent investment adviser serving both individual and institutional investors globally