XLC: Bullish Technical Features Unfolding, Rating Upgrade

The Communication Services sector has been the strongest performer so far in 2023. Bucking what so many market strategists had called for coming into the year, shares of names like Meta Platforms (META) and Alphabet (GOOGL) (GOOG) have rebounded impressively amid a pullback in yields and a severe underweight among many investors to growth-heavy sectors following last year’s plunge in the space.

I now see the valuation picture as decent while the technical situation has improved sharply. While muted EPS growth is seen this year, I think much of that pessimism appears to have been priced in over recent quarters, and investors are now looking ahead.

I am upgrading the fund to a hold, and am watching one key technical level.

Year-to-Date Sector Returns: XLC Top of the Pack

Digging into the portfolio, Communication Services Select Sector SPDR Fund (NYSEARCA:XLC) is interesting in the fact that it is not as ‘growthy’ as you might imagine following price action among its largest components in recent months. The Morningstar Style Box puts the fund nearly evenly distributed among value, blend, and growth. Meta Platforms was one of a handful of mega-cap tech(ish) names that were considered by some to be value in nature as of the end of 2022 due to its still-decent earnings profile amid an intense stock price selloff.

The fund features a yield of under 1% while its forward price-to-earnings ratio is about on par with the broad market’s at just under 19 times. With a price-to-sales ratio barely above 2, it is not overly expensive. Long-term earnings growth trends suggest the normalized forward operating PEG ratio is actually attractive at under 2. Momentum is listed as low right now, but I imagine several of the ETF’s holdings will be tossed into the popular momentum funds in due time.

XLC: Portfolio & Factor Profiles

XLC is a concentrated portfolio with more than half of the allocation weighted into the top two positions. So, monitoring trends in Meta Platforms and Alphabet is key. Those companies report results during the middle part of the earnings season ahead.

XLC: Top 10 Holdings

Seasonally, XLC tends to move sharply higher now through late July. Consolidation tends to take place later in Q3 through the first handful of weeks of Q4. So, now is a favorable time for an overweight position in the Communication Services sector, according to what data suggests from Equity Clock.

XLC: Favorable Seasonal Trends

The Technical Take

Late last year, I was bearish on XLC, but that proved to be the wrong call. While there was near-term volatility in late October and November, a bullish rounded bottom was being formed. I now see key resistance in the $59 to $61 range. A breakout above that zone would imply a bullish measured move price objective to near $77. That would put the fund back to where it traded in early last year. What is also appealing about the technical situation is the rising RSI momentum indicator.

Notice in the chart below that both momentum is on the mend and there are bullish volume trends during recent upward thrusts in the share price. Overall, the chart is constructive, and a rally above $61 would only serve to further augment the bullish technical narrative. A drop under $51, though, would be problematic and put the uptrend off the November low in major jeopardy.

XLC: Bullish Rounded Bottom Forming, Eyeing Low $60s Resistance

The Bottom Line

I am upgrading XLC from a sell to a hold. My rating last year was wrong, and with new data and a refreshed outlook, I see a bullish technical feature unfolding on this fairly valued fund.