October 12, 2018 / 3:57 PM / 2 months ago

Wall St Week Ahead-New communication sector's shine could soon wear off

    By April Joyner
    NEW YORK, Oct 12 (Reuters) - The mash-up of old and new
media may not be a winning combination for the new S&P
communication services sector           as its highest fliers
face regulatory threats and challenges to user growth.
    The reconstituted sector, which debuted at the end of
September, includes telecom, internet, media and entertainment
companies such as AT&T Inc      , Walt Disney Co         and
Twitter Inc         . 
    Three of the five momentum stocks collectively known as
FAANGs - Facebook Inc       , Netflix Inc          and Google
parent company Alphabet Inc           - make up roughly half of
the new sector by market capitalization.
    Facebook and Alphabet moved to communication services from
the technology sector          . Netflix was previously in the
consumer discretionary sector          . The other FAANG stocks,
Amazon.com Inc          and Apple Inc         , remain in the
consumer discretionary and technology sectors, respectively.
    The addition of several FAANG stocks, among the
fastest-rising shares on the S&P 500       , has brought more
attention to the once-sleepy sector, formerly known as telecom.
Indeed, so far communication services has closely tracked the
tech sector. Both have slid significantly during sell-offs in
October, including a 5.3-percent drop for the S&P 500 over
Wednesday and Thursday. 
    The two indexes recovered somewhat in trading on Friday. The
communication sector was last down 5.3 percent month-to-date,
ahead of tech's 6.2 percent slide.
    On one hand, the communication sector's old-media names have
cushioned it somewhat in comparison to tech's steeper plunge.
But those less growth-oriented companies also limit the sector's
upside potential. 
    Also, several of the sector's growth companies - Facebook,
Alphabet and Twitter - face regulatory risks that tech companies
do not. Recent disclosures of privacy breaches have increased
concern among some investors that the U.S. government could soon
target internet companies with new regulations.
    "The regulatory pendulum tends to swing from 'not enough' to
'too much,' and it will take time to balance," said Scott Wren,
senior global equity strategist at Wells Fargo Investment
Institute in St. Louis. "In the meantime, we have to think about
overregulation."
    As a result, market strategists have been less than
enthused. On Monday, Wells Fargo Investment Institute gave the
sector an "unfavorable" rating. Bank of America Merrill Lynch
and RBC Capital Markets rate the sector "underweight."
     On Monday, Google announced that private data from 500,000
users of its Google+ social network, whose consumer version is
being shut down, may have been exposed to external developers.
             On Sept. 28, Facebook said that hackers had stolen
digital login codes allowing them to take over nearly 50 million
user accounts.             
    Executives from Facebook and Twitter had testified before
Congress in September on their companies' data security
practices.
    Another communications high-flier, Netflix, faces a separate
challenge. Netflix's shares dropped 5.2 percent on July 17 after
the company's rate of international subscriber growth in the
second quarter underwhelmed investors. Another disappointing
number for international growth could alarm investors, said
Daniel Morgan, senior portfolio manager at Synovus Trust Company
in Atlanta.
    "That would be a concern because Netflix is so dependent on
the international side in terms of its growth," Morgan said.
"The domestic side has become pretty mature."
    Netflix is scheduled to report its third-quarter results on
Tuesday.
    Given the risks to the communication sector's internet
stocks, the sector is less attractive than technology or
consumer discretionary for investors seeking growth, said Wren.
At the same time, the sector's relatively high price-to-earnings
ratio and low yield make it unsuitable for value-oriented
investors.
    Also, two communication stocks, Netflix and Alphabet, are
among the most trade-sensitive within the 100 largest U.S.
stocks by market cap, according to an Oct. 4 note from Morgan
Stanley. 
    Both have been more reactive to Chinese market assets
relative to other large-cap stocks since March, when U.S.
President Donald Trump first announced tariffs on Chinese goods,
said Brian Hayes, quantitative analyst at Morgan Stanley, in an
email to Reuters.
    To be sure, the FAANG stocks remain among the most popular
buys on Wall Street. The NYSE FANG+TM           index, which
holds those stocks along with several other growth stocks,
including Twitter, is up 15 percent year to date, well above the
S&P 500's 3.2-percent advance.
    But with that popularity also comes outsized potential for
downside in the sector they dominate.
    "The level of valuation tends to be quite high," said Tim
Ghriskey, chief investment strategist at Inverness Counsel in
New York. "That's the primary issue here and the primary risk."

 (Reporting by April Joyner; Editing by Alden Bentley and Nick
Zieminski)
  
 
 
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