Amazon.com is one of the biggest, and therefore most influential, stocks in the U.S. equity market, and it has surged more than 30% so far this year. Netflix is another trading favorite, up more than 20% in 2017 and nearly 60% over the past 12 months.
So here’s a trivia question: how much have these iconic stocks, both of which embody the current internet age, directly contributed to the gain of the overall technology sector, itself the biggest gainer of the year, up more than 14%?
Trick question—they’ve contributed nothing.
That answer may come as a surprise, given that Amazon AMZN, +2.44% and NFLX, +0.41% are two of the biggest buckteeth in FANG, the quartet of internet stocks (along with Facebook FB, +0.56% and Google parent Alphabet GOOGL, -0.16% ) that have fueled market gains over 2017. However, neither company is technically a technology stock; both are allocated to the consumer discretionary sector.
Amazon is the largest name in that industry by far, accounting for nearly 15% of the sector, based on its weight in the Consumer Discretionary Select Sector SPDR ETF XLY, -0.03% the largest exchange-traded fund to offer broad-based exposure to the group (Netflix is 2.5%, the 12th largest holding). Investors who bought the Technology Select Sector SPDR ETF XLK, -0.17% hoping to capitalize on Amazon’s or Netflix’s massive growth stories actually got no direct exposure to them at all.
Wall Street is riddled with such counterintuitive sector placements, and this has become more of an issue as companies expand into business lines that are outside of their primary industry.
“Companies today are not old fashioned monoliths that only do one thing; they do a wide range of stuff,” said David Blitzer, who, as the chairman and a managing director at S&P Dow Jones Indices helps decide which sector S&P 500 companies are assigned to. Companies with major presences in multiple sectors “is an issue that we’ve been increasingly grappling with in the past few years.”
A number of companies appear in sectors that one might not expect. American Express Co. AXP, +0.93% is in the financial sector, but credit card rivals Visa Inc. V, +0.00% and MasterCard Inc. MA, +0.44% are both classified as technology names.
“I’ll admit this is a little inconsistent,” Blitzer said, “but Visa and Mastercard don’t have any money [like financials do]. What they do is run the highly secure communications system between the guy and the drugstore and the banks all over the world. That technology is their business. They are, in effect, a specialized telephone company.”
Speaking of which, telecom giants AT&T Inc. T, +0.31% and Verizon Communications VZ, -0.02% are also in the technology space, though Blitzer said there were debates about whether they should be considered industrial or utility stocks, as aspects of their businesses had characteristics of both. Verizon, meanwhile, has also been expanding its presence in the traditional tech industry, with its acquisitions of AOL and Yahoo YHOO, +0.00%
(There are 11 S&P 500 sectors, and one of them is dedicated to telecommunication stocks. However, there are only 10 select sector indexes because there aren’t enough telecom stocks to merit their own distinct index.)
But Amazon is perhaps the biggest example of how difficult it has become to classify stocks within a single sector category. That it is classified as a discretionary name is certainly logical. While it is “the epitome of the tech business,” as Blitzer described it, Amazon is also one of the biggest names in retail, just of the (mostly) online sort. However, a notable part of Amazon’s revenue comes from its cloud-computing technology, a business segment that, were it spun out into its own company, would likely be considered tech, even though it could be argued it has many of the same attributes as a utility. Amazon also has begun producing its own video content, something that makes it a competitor to media companies.
Further complicating the issue, consumers use Amazon to buy consumer staples, not just discretionary items, unlike the retailers that cater to more specific consumer categories. And on Friday, Amazon agreed to buy Whole Foods WFM, +29.10% which, as a grocery store, falls into the consumer staples space.
Companies can’t be in two sectors at once, so what keeps Amazon in discretionary?
Sector assignments are dictated by the global industry classification standard, which is a joint effort between S&P Dow Jones and MSCI. To classify a company, the GICS team looks at its different revenue streams, which determine what various subindexes the company fits into. There are more than 170 such niche categories, but if more than 65% of a company’s revenue is in one subindex, the company is assigned to whatever sector that subindex fits into. In Amazon’s case, the online retail business—discretionary spending, for the most part—surpasses this threshold.
“If you’re making 10% of your money from cloud computing and 90% from selling stuff, you’re selling stuff,” Blitzer said. “From our point of view, it’s a retailer.”
Other companies are harder to classify, with Blitzer singling out Warren Buffett’s Berkshire Hathaway BRK.B, -0.04% as a particularly confounding one. “It’s an insurance company that owns a railroad. Other than the fact that it makes a bundle, I can’t figure it out.” (It’s in the financial sector, because “the only things its components have in common is their financial linkage.”)
In the event that the revenue streams involve diverse subindexes, Blitzer said that sometimes “market perception” was taken into account. Ergo, PepsiCo Inc. PEP, -0.30% will always be classified as a beverage company first and foremost, even though a majority of its sales come from food.
There is precedent for companies jumping from sector to sector as their business focus changes. Perhaps most notably, S&P last year decided that real-estate companies had become prominent enough on their own to merit their own separate category. As such, they were spun out from their former home, financials.
Investors are increasingly looking to passive index-based funds to get broad exposure to the market, and the 10 Select Sector funds are among the most popular ways to make bets on individual sectors; the 10 SPDR ETFs have $121.6 billion in combined assets, according to FactSet data. Because of this, confusion about where companies do or should fit can cause a problem. If Amazon moves on tech news, that can have an influence on the rest of the consumer discretionary sector.
Blitzer said he was aware that some people may buy a sector fund to get exposure to a particular trend and not realize the companies they want aren’t actually in it.
“It seems like no one reads the prospectus, and that no one outside our office reads the methodology of our funds,” he said. “I’d like everyone to read the documents carefully, but if they don’t, so long as our stuff is correct and available, we’ve done as much as we can.”