Unlikely Leadership From Unloved Group

Telecoms such as Qwest and Verizon get little respect but help major averages rally again.
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Disliked sectors get little attention, even when they're rising. Shunned by Wall Street since the end of the tech bubble, the telecommunications services sector has been the strongest performer of the

S&P 500

since the beginning of the year.

Telecom is up 10.4% for the first quarter through Wednesday's close. That's well ahead of the roughly 3% gains seen for energy and materials -- which have undergone a mini-meltdown over the past two weeks. Telecom's performance also compares well with the S&P as a whole, which is up 2.5% so far this year.

Only eight stocks make up the S&P telecom services sector:

Alltel

(AT) - Get Report

,

AT&T

(T) - Get Report

,

BellSouth

(BLS)

,

CenturyTel

(CTL) - Get Report

,

Citizens Communications

(CZN)

,

Qwest

(Q)

,

Sprint Nextel

(S) - Get Report

and

Verizon

(VZ) - Get Report

.

Qwest generated some excitement for the sector last week when it announced that it had increased revenue last year for the first time since 2001. The company also hinted it might return to profitability in 2006, quite a turnaround from four years ago when the company was nearing bankruptcy amid $26 billion of debt.

Some investors have been on the case since last year, as Qwest rose 27.3%. Ye, the stock has risen another 9% so far this year, including a 5% gain on Thursday, while the

Dow Jones Industrial Average

rose 19 points, or 0.2%, to 11,078, touching its best level since June of 2001.

Hewlett-Packard

(HPQ) - Get Report

, which posted strong profits Wednesday after the close, rose 7.4%.

The

S&P 500

rose 0.3% to 1284, and the

Nasdaq Composite

gained 0.6% to 2289.

Qwest's comeback is only one of many in the industry. Telecom, it seems, has learned the hard lessons of excess investment in the 1990s which then led to a network glut that lasted for many years.

According to Morningstar telecom analyst Michael Hodel, much of the comeback is due to the massive consolidation seen over the past few years in the industry: Among the biggest moves, Sprint bought Nextel, SBC bought AT&T, Verizon bought

MCI

, and

Level 3

(LVLT)

bought

WilTel

.

This consolidation, Hodel writes, is finally giving surviving telecom giants enough weight to withstand competition from cable companies, and is allowing some pricing power, which should bode well for profits.

In the wireless arena, the strongest players such as BellSouth's Cingular Wireless are also finally reaping the benefits of integrating new technologies, with growth seen in such areas as voice over Internet protocol. The developments of new wireless gizmos is also allowing the likes of Verizon and Sprint to start dreaming of competing with

Apple's

(AAPL) - Get Report

iPod.

Yet you'd be hard-pressed to find many headlines about the telecom sector, especially not ones hinting at the possibility of a sustainable comeback. In fact, Wall Street remains suspicious of telecom's growth prospects.

"Even if

telecom is up 10% this year, it's done nothing for the past four years," says Barry Hyman, market strategist at Ehrenkrantz King Nussbaum. "And it's hard to make a case for growth in the sector given the heavy competition with cable, and remote attempts at competing with Apple."

Hyman's theory about Wall Street's recent, still secret love affair with telecom is that telecom offers safety for investors nervous about a slowdown in profits later this year. "Telecom is one of those safe large-cap sectors, where many stocks pay dividends, and it's up for the same reason that the Dow Jones Industrials have been doing well," Hyman says.

Telecom continued to outperform the broad indices, with the Amex telecommunications index advancing 1.8%.

Telecom remaining one of the least-loved sectors is what gives Merrill Lynch strategist Richard Bernstein hope that it still has room to run higher this year. Sectors or stocks that are overcrowded and praised for everything they do are more susceptible to disappoint, as was the case with

Google

(GOOG) - Get Report

recently.

But on a broader note, if investors are indeed favoring the Dow and other defensive large-caps such as telecoms, it means that a great deal of caution lies beneath the overall bullish tone on Wall Street recently. That's not so bullish for the growth prospects of any industry.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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