Since the beginning of the year, every S&P 500 sector is in positive territory. The worst performers year-to-date (YTD) are the utilities and consumer staples sectors, which are both defensive. Each sector is up about 12% for the year.

In third place is the communication services sector, which is up 14% YTD. But if we look at just the past three months, a different picture emerges. During that timeframe this sector has lost 9%, the only S&P 500 sector to decline during that period.

Just what is the communication services sector? This sector includes diversified telecommunication services, wireless telecommunication services, media, entertainment, and interactive media and services. Components include Meta Platforms (NSDQ: FB), which most people still know as Facebook, Alphabet (NSDQ: GOOGL), and AT&T (NYSE: T).

If we drill down into the subsectors, we find the reason for this sector’s underperformance. The media and entertainment companies have had a pretty good year. Alphabet, whose stock classes make up a whopping 25% of the index, is up about 70% for the year. Facebook makes up another 22% of the index and is up 21% on the year.

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But if we take a look at the telecom subsector, officially known as “Diversified Telecommunication Services,” we find the laggards. AT&T is down 21% on the year. T-Mobile Us (NSDQ: TMUS) and Verizon (NYSE: VZ) are both down 15%.

AT&T’s challenges…

AT&T confronts a unique set of issues. Activist investors had demanded change at the company, and earlier this year AT&T announced some big strategic shifts. The company is forming three entities:

• AT&T: a telecom company solely focused on 5G communications and broadband.
• DirecTV: a separate company, with 70% owned by AT&T and a 30% minority stake sold to TPG, a large private equity buyout firm.
• Warner Bros. Discovery: a spin-off of WarnerMedia, merged with Discovery (NSDQ: DISCA).

These deals will generate $50.7 billion for AT&T to be able to pay down its debt. Most analysts argue these were necessary moves for AT&T, but the company is expected to make a 40% dividend cut to reflect its new, smaller business. This all creates uncertainty, and that has helped drag down AT&T’s shares.

But across the entire telecom subsector, fierce competition between these major providers has led to doubts among investors that these companies can continue to grow profits. I just upgraded my phone a couple of weeks ago, and I was astounded at the deal I was able to get. But those deals are a serious drain on profits.

It also doesn’t help that recent auctions for wireless airwave licenses have highlighted the high capital requirements for boosting network capacity.

Telecoms are generally viewed as more conservative income stocks, and in recent years they have underperformed the S&P 500. But current valuations are below the 10-year averages.

Last month a Reuters article cited a couple of analysts who believe shares are too cheap to ignore:

“When you look at the valuation of the stocks relative to those issues, it seems to me that the market is way over-reacting,” said Stephen Massocca, senior vice president at Wedbush Securities, who has purchased Verizon and AT&T shares as recently as October.

Bill Stone, chief investment officer at Glenview Trust Company, started buying AT&T shares early this year despite competition concerns, as they were “frankly, too cheap.”

I agree with their assessment. I don’t know that next year the sector will match the performance of the energy sector this year, but I see a similar dynamic. A year ago we were bemoaning the under-performance of the energy sector, and this year it is the top-performing sector. I think we will look back on this period as the time the telecoms became too cheap to ignore.

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