Technology stocks have been on quite a tear in recent years. Plenty of ink has been spilled detailing the incredible gains of the FAANG stocks (Facebook, Apple, Amazon, Netflix, Google), and rightly so. Those five stocks have averaged gains of nearly 60% over the past year, and more incredibly, have average annualized gains of ~38.5% over the past five years.
SMI investors who are invested in Sector Rotation have seen similar eye-popping returns (+69.7%) over the past year in a different part of the tech realm, and five-year annualized returns of ~33% from a variety of sectors.
As I said, that part of the story is pretty well known. What isn't as widely appreciated is that big tech has been growing faster than everything else for quite a long time. Josh Brown reports that the Information Technology sector has grown from ~10% of the S&P 500 at the end of 2000, to 15% in 2006, to a whopping 24% by the end of 2017.
When big companies grow at the type of rate we've seen lately from the FAANGs (and other tech), they start taking up an increasing share of the major indexes, which are weighted by market capitalization. One byproduct of that is the "diversified" major indexes such as the S&P 500 are increasingly dominated by this group of somewhat similar stocks.
Passive management gets active
While not much can be done about that in terms of the broad indexes, the people at MSCI and S&P Dow Jones Indices who are responsible for such things decided last fall that enough was enough. They've put in motion a plan to spread out some of these tech heavyweights among various sectors and re-weight them. This involves changing some sector names (Telecommunications is becoming Communication Services), and reclassifying a number of "tech" companies as other things, such as Communications.
Ultimately it's an effort to rebalance some of these sectors a bit. While it may not make a big impact on the overall indexes, the reclassifying of certain stocks could result in some shakeups further downstream, such as in some of the funds included in the Sector Rotation universe. I would imagine that, for example, the Telecom funds in our universe will look pretty different after Facebook and perhaps Apple join the new "Communications Services" group.
There's an irony here that won't be a surprise to those who really understand index funds. Namely, it's that behind these vehicles favored by passive investors are committees of people making very active decisions about what is the best way to configure these indexes. (Side note: some of those decisions are totally befuddling. As Brown points out: "Why is Walmart a Consumer Staple and Target a Consumer Discretionary — don't we buy the same stuff from both, pretty much?") Many years ago, I used to trade the stocks that were being added or subtracted to the main S&P indexes because even then, before indexing had gotten as big as it is today, those stocks would rise and fall dramatically on the news of being added or kicked out of the big indexes. There's really no such thing as truly passive investing, only varying degrees of activity.
Brown thinks these changes are going to require ripping up most Sector Rotation strategy approaches, and that may be true if they're based on the GICS (Global Industry Classification Standard) sectors shown in the chart above. However, I'm not particularly concerned about SMI's version of SR. For starters, we don't use those GICS sectors per se. More importantly, our approach to selecting sector funds should still lead us to the better-performing ones, regardless of how the individual stocks get sorted between them. It's not as if there's been one great Information Technology fund we've been riding the past five years and now it's being blown up. In fact, during this recent five-year stretch when SR has been posting huge returns, almost none of its gains have come from funds invested in the FAANG stocks.
So if you see any news later this fall about a shakeup in the index sectors, you'll know what's going on. You can safely tune it out and carry on as normal.