The telecom sector, one of the smallest sector weights in the S&P 500 but still a favorite for investors seeking income, is scuffling this year. However, the usually slow-growth industry is experiencing changes that could bode well for long-term investors.
Telecom ETFs such as the Vanguard Telecommunication Services ETF (NYSEArca: VOX) and the iShares U.S. Telecommunications ETF (NYSEArca: IYZ) are struggling due in part to expectations of more interest rate hikes from the Federal Reserve. The combination of the sector’s defensive posture and robust dividend yields gives telecom bond-like traits, making the group potentially vulnerable when borrowing costs climb.
International telecom stocks and exchange traded funds represent an option for yield-starved investors that are also looking to reduce their exposure to rising U.S. Treasury yields. That theme can be accessed with the iShares Global Telecomm ETF (NYSEArca: IXP).
Some analysts are bullish on big-name telecom stocks, including AT&T and Verizon, even though those stocks have run up this year. Importantly, those stocks are not stretched on valuation. However, it is AT&T and Verizon that are hampering the likes of IYZ and VOX year-to-date. Those stocks combine for significant portions of the rosters in those ETFs. In the case of VOX, the Vanguard teleom ETF, AT&T and Verizon combine for 46% of the fund’s weight.
“Over the last few years, the industry has been undergoing a transformation, with telecom companies foraying into content distribution, upstart wireless firms grabbing market share, increasing digital data usage, and more,” said Morningstar in a recent note.
In a uneven market where raw materials-related sectors are underperforming in a depressed commodities environment, the telecom space has stood out as a positive driver of market earnings. Telecom services are seen as one of the few ares of positive earnings growth. Consolidation trends loom large for telecom ETFs.
“It’s also unclear how the content play that some wireless firms have been engaging in will work out. If AT&T’s purchase of Time Warner goes through, it will own a lot of high-quality programming, such as HBO’s lineup, which could allow it to generate advertising revenues and reduce the price it pays to show content on its various platforms,” according to Morningstar. “It may also give subscribers content-specific benefits, similar to how AT&T provides customers free data streaming for DIRECTV Now. (AT&T purchased the satellite business in 2014.)”
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