The Cost of Disruption

It’s Friday, and stock traders once again would rather be holding long positions before the weekend.  If the S&P 500 (SPX) can hold onto this morning’s gains, this would be the 11^th Friday with a higher close of the 14 since the start of the third quarter.[i]  Yesterday, we dipped on some inconvenient news reports about AI.  Today, we’re getting a broader advance.

A long run of upward Fridays is a feature of a market in a powerful uptrend.  In skittish markets, weekends are perceived as risky.  Plenty of things can go wrong during a two-day weekend.  When markets are in rally mode, the bigger short-term risk is perceived as being short, or out of the market.  As a result, today’s tide is raising a wide array of stocks and sectors.  Only communications and consumer staples stocks are lower.  Consumer stocks have been suffering for some time, with today’s modest declines abetted by a weak Preliminary University of Michigan Sentiment reading (46.3, down from the prior 48.1).

Communications stocks are a more interesting story today.  This sector is considered another proxy for the artificial intelligence buildout, since it is dominated by Meta Platforms (META) and Alphabet (GOOG, GOOGL).  Each of those companies represents over 20% of the sector’s market capitalization, meaning that the two companies (three share classes) comprise about 45% of the sub-index.  It can be easy to forget about the companies that make up the other half.  Today, we can’t forget about them, especially the 6^th, 7^th, and 9^th largest components of that sector.

Yesterday, SpaceX (SPCX) announced that it would be buying wireless spectrum that would potentially allow it to compete with established telecom providers.  To put it bluntly, that is freaking out investors in the telecom sector.  AT&T (T), T-Mobile (TMUS), and Verizon (VZ) are all down by more than 9%, with TMUS down by more than 12%.  Though the combination of those three stocks comprises only a bit more than 13% of the sector, their significant declines are sufficient to drag down the sector – even as META, GOOG, and GOOGL are all modestly higher. 

Those three telecom stocks, which are quite similarly sized, have a combined market capitalization of just under $500 billion.  That is less than one quarter of SPCX’s valuation.  Each has lost about $20 billion in market capitalization today, with SPCX increasing by about $27 billion.  It is useful to remember that SPCX is not a component of SPX, so the full downside brunt, but none of the upside, of SPCX’s purchase is reflected in the benchmark.

Investors who hold normally boring telecom stocks were clearly blindsided today.  All three were already near their lows for the year, with TMUS now touching a new low today.  If there is a silver lining to today’s declines, it is that each of those stocks is now yielding more than 3%.  In fact, T is flirting with a 5% yield, which is above that of 2-year Treasuries.  Severe competition from a new entrant could certainly put pressure on those companies’ ability to maintain the cash flows necessary to sustain their large dividends.  The question, of course, is when that pressure might truly disrupt a relatively sleepy sector.               

[i] Markets were closed on first Friday of Q3 which was July 3^rd, when the Independence Day Holiday was celebrated.  Interestingly, SPX was up a mere 0.01 points on Thursday, July 2^nd.