Why Are Telecom ETFs Significantly Outperforming The Market?

Includes: IYZ, VOX
by: Gary Gordon

Telecommunication service providers from Verizon (NYSE:VZ) to AT&T (NYSE:T) to Sprint Nextel (NYSE:S) have rocketed over the last three months. Some attribute the share price appreciation to investor thirst for high dividend yields. Others regard telecom as a non-cyclical sector like healthcare and staples, where economic concerns may be driving participants toward safer havens.

Then again, there may be multiple reasons for the “tele-tremendous” results. Sprint’s second quarter earnings and revenue crushed expectations, sending company shares into orbit; gains have approximated 30% over the previous five trading days. Similarly, worldwide demand for wireless services is so strong, cell phone tower owners like American Tower (NYSE:AMT) benefited from 17% second quarter growth in sales. In other words, unquenchable desire for more and more mobile data usage is likely boosting telecom’s success.

That said, there have been noteworthy patterns of performance in the leading Telecom ETFs like Vanguard Telecom (NYSEARCA:VOX) and iShares DJ Telecom (NYSEARCA:IYZ). Consider the relative strength of VOX in Q2 2012 as evidenced by the VOX:SPX price ratio below.

Click to enlarge

VOX vs. SP 500 Q2 2012Click to enlarge

Now take a look at the same 3 month period (4/1-7/1) for 2010…

VOX vs. SP 500 Q2 2010Click to enlarge

and 2011…

VOX vs. SP 500 Q2 2011Click to enlarge

The pattern is unmistakable. We can debate the reasons why telecom out-hustles the broader S&P 500 in the second quarter. Some will say it is a function of “sell in May and go away,” whereby less risky segments (e.g., healthcare, staples, telecom, utilities, etc.) thrive. Others will say that it has more to do with anticipating prominent smart phone introductions and the effect that those introductions may have on the wireless data carriers.

Personally, I’m not too sure that it matters. The fact remains that the telecom train tends to be spectacular from early spring through early fall. And for those who have a plan to enter as well as exit positions, rather than buy-n-hold, both Vanguard Telecom (VOX) and iShares DJ Telecom (IYZ) are reasonable “seasonables.”

Keep in mind, though, both VOX and IYZ tend to underachieve in higher beta ”risk-on” rallies. What’s more, they even fare worse than the S&P 500 in panic sell-offs where babies get tossed out with their tub toys.

From a pure valuation stand-point, it’s hard to argue that telecom ETFs are a bargain. The 3% yields may be more attractive than the market, yet the immense weighting of Verizon (VZ) and AT&T (T) in these exchange-traded vehicles leaves little room for missteps. If you buy today, be sure to place a trailing stop-limit loss order.

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.