Are U.S. Stocks Diverging from the U.S. Economy?

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Are U.S. Stocks Diverging from the U.S. Economy?

Postby Simplegift » Wed Dec 19, 2012 3:14 pm

Each year on the Forum, someone posts the annual statistics from S&P showing the percentage of revenue earned overseas by U.S. companies — up from 10% in 1970 to over 46% in 2011. In this post, I'd like to look a bit deeper into this growing trend and explore some of the consequences for the U.S. stock indexes in which we all invest. First, a current breakdown of the S&P 500 stocks by their percentage of foreign revenue (from Bespoke Investments):

    • More than 50% foreign revenue………122 stocks (24%)
    • Less than 50% foreign revenue…….…257 stocks (52%)
    • No foreign revenue……………..……....121 stocks (24%)
Diverging Stock Returns: One now sees financial analysts beginning to separate those U.S. companies with high foreign revenues (the internationals) from those with domestic-only revenues (the domestics), almost as if they were two entirely different indexes. Here's an example, showing these two stock groups as the European debt crisis unfolded during 2012:

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Source: Bespoke Investments

Influence of Europe: Of the two-thirds of S&P 500 foreign revenues that were reported by region in 2011, about 25% came from Europe, 15% from Asia, 10% from North America, 8% from Africa and 6% from South America. Thus Europe still remains the dominate U.S. export market, with a large influence on U.S. stock indexes. The emerging economies of Asia, South America and Africa have a smaller, but growing, impact.

Influence of U.S. Dollar: Increasing foreign revenues mean U.S. stock indexes are increasingly impacted by U.S. dollar fluctuations. When the dollar weakens, U.S. exports become more competitive worldwide and U.S. multinationals benefit from increased sales — and vice versa. Though not always negatively-correlated with the dollar, U.S. stock indexes are increasingly moving in step with international stock indexes.

Less Dependence on U.S. Consumer: As the U.S. population ages and domestic consumer demand falls, the success of U.S. companies depends on their ability to penetrate foreign emerging markets, especially in Asia, and to attract international consumers to their brands. And if the "stagnationists" prove correct about the future U.S. economy, these foreign revenues should provide a significant buffer for U.S. stock indexes. Your thoughts?
Last edited by Simplegift on Wed Dec 19, 2012 3:50 pm, edited 1 time in total.
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Re: Are U.S. Stocks Diverging from the U.S. Economy?

Postby NYBoglehead » Wed Dec 19, 2012 3:45 pm

Very interesting data and thoughts.

If I'm not mistaken, I believe Jack Bogle has said something along the lines of International Allocation not being as important as in years past since so much of the revenues from the S&P 500 are coming from overseas (And the S&P 500 makes up something like 80% of TSM, if I'm not mistaken).

Not sure if that has swayed anyone's AA.
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Re: Are U.S. Stocks Diverging from the U.S. Economy?

Postby Simplegift » Wed Dec 19, 2012 6:15 pm

NYBoglehead wrote:Not sure if that has swayed anyone's AA.

The foreign revenue numbers for U.S. companies shouldn't sway anyone's asset allocation, IMO.

What the revenue numbers obscure is the lopsided industry exposures between U.S. and international companies. Looking at total global market cap (below), U.S. companies dominate in the "new economy" fields of computers, biotechnology, software, IT services, etc. — while foreign companies dominate in the "manufacturing" fields of office electronics, automobiles and auto components, electrical equipment, household durables, etc. Since the foreign revenues of U.S. companies are skewed to certain industries, one needs a healthy allocation to international equities as well, just to balance global industry exposure.

Image
Source: Vanguard Institutional
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Re: Are U.S. Stocks Diverging from the U.S. Economy?

Postby Karamatsu » Wed Dec 19, 2012 8:39 pm

I'm not sure if any conclusions can really be drawn from the data. Any way you divide up the index you're going to find multiple variables. Given that more than half of the companies are in the middle (neither "internationals" nor "domestics") the graph just represents the extremes. Also just by eye it looks like the divergence occurred suddenly in May/June and everything since then both groups have moved more or less in lock-step, so there's less systemic divergence than may first appear.

It would be interesting to see data on the actual revenue, rather than number of companies, since there is a large range of annual revenue in the S&P. Also you could factor out exchange rates to get an idea if the "internationals" are actually growing or shrinking in terms of local market revenue and overall corporate earnings. Finally you can't look only at export revenue. A falling dollar means that imports are more expensive for US companies, and since the US imports massive amounts of those "old economy" manufactured goods to fuel its "new economy" (haven't heard that phrase in a while!) services, the increased costs will negatively affect earnings.

Either way the divergence is only six months old and on the time-scale that most of us are investing for, that's nothing. But maybe good to keep an eye on...
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Re: Are U.S. Stocks Diverging from the U.S. Economy?

Postby Simplegift » Wed Dec 19, 2012 11:45 pm

Karamatsu wrote:Either way the divergence is only six months old and on the time-scale that most of us are investing for, that's nothing. But maybe good to keep an eye on...

Just wanted to clarify that the chart in the OP is only an example of how financial analysts are increasingly treating the stocks with high foreign revenues as a separate class from those with domestic-only revenues. It's an example of short-term divergence only.

More instructive is a longer-term growth chart, below, of Vanguard Total Stock Index (in blue) and a US dollar ETF (in orange). They've had an almost perfect inverse relationship over the past 5 years — which seems to indicate that U.S. stock indexes are being more strongly influenced by fluctuations in the dollar, rather than factors in the domestic U.S. economy. Perhaps something else is happening here, but I suspect the significant foreign revenues of U.S. companies are driving this divergence.

Image
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Re: Are U.S. Stocks Diverging from the U.S. Economy?

Postby BlueEars » Fri Dec 21, 2012 7:24 pm

Maybe this chart shows a similar story? The Euro declined a lot in May versus the dollar (see gold FXE line). Hence the spread widened between US (Total Stk Mkt) and European shares (VEURX). However, the spread also widened between the US and emerging markets (VEIEX). So clearly this affected stock prices along with currency differentials. Later it appears this spread disappeared (US vs VEIEX) and even went negative (US and VEURX).


Image

My guess is the spread might just change again -- not a very bold prediction. :happy
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Re: Are U.S. Stocks Diverging from the U.S. Economy?

Postby Simplegift » Fri Dec 21, 2012 9:36 pm

I wish I had the opportunity to research this topic in more detail, but I suspect the large-cap U.S. stock indexes are now much more correlated with global GDP — global investment spending, commodity demand/prices, exports and FX — than domestic U.S. consumption or housing, which have driven the U.S. indexes in the past. The divergence is now something like this:

    US Economy……………..………..S&P 500
    Domestic……………………….…..Global
    Consumption-Driven………...….Investment-Driven
    Service-Oriented………………….Manufacturing-Oriented
    Net Importer……………………….Net Exporter
    Prefers Strong Dollar……………..Prefers Weak Dollar
    Net Borrower…………….….……..Net Saver
In short, the interests of the U.S. multinationals and exporters that dominate our U.S. stock indexes (and thus our equity investments) are no longer aligned with the U.S. economy.
Last edited by Simplegift on Fri Dec 21, 2012 10:40 pm, edited 1 time in total.
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Postby maddyken » Fri Dec 21, 2012 10:00 pm

Boy am I glad I invest at the business level.
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