In January 2016, we experienced the worst 10 day start of the stock market since 1897. I’m an economics history guy and that’s saying something. If not for the 396 point comeback on the last day of the month, the Dow decline of 5.5%[i] would have looked a lot worse.
In the November 2015 newsletter we talked about the formation and the independence of the US stock market. In this letter, I want to talk about the interdependence of world financial markets. It’s not 1985, and I certainly ain’t no Michael Jackson, but ‘We Are The World’ could have been the title of this piece.
Consensus opinion has the S&P 500 earnings rising 7% in 2016 (in the range of $125). That figure would indicate stocks would rise plus or minus that number. Not a great year, but not a bad year, and portfolios would take a nice little bump up.
The above might happen, but as you know we are not the predictor of market prices. Further, not everything tidily fits in the equation if just talking about the strength or weakness of the U.S. economy. There are at least three other significant factors that must be considered when talking about our stock market because we are more connected to the rest of the world than we have ever been in history. Specifically, for your next cocktail hour sharing;
- Foreign trade (non-US buyers of our stuff) makes up an increasingly large share of the economy. We certainly have become more energy independent in the last 6 years, but as a percent of our business foreign trade in the U.S. economy we have become more dependent, increasing from 18% in 1998 to 23% today. For large companies (think again S&P 500), saw 27% of their profits earned overseas in this decade compared to 17% in the 1990’s[ii]. When the world gets a cold, we begin to sneeze.
- Then we have the reality that our currency is not their currency. The U.S. dollar has appreciated substantially against most currencies in this past 10-year period and that means sales and earnings from overseas work are converted into few U.S. dollars when translated. In one particularly impressive sector, small and large high-tech companies offer attractive products to international buyers. Apple just reported it gets 66% of its revenue outside the USA. Information technology companies in the broader Dow Jones Indices are estimated to have obtained 59% of their 2014 sales overseas[iii] (latest numbers available). S. owned companies must report in dollars, so they report ‘less’ when the dollar is ‘more’.
- Psychologically, we are more aware of the world than we have ever been, though arguably foreigners have typically been fairly attuned to what is happening in this country. When we feel good, we buy more, invest more for the future. When we are nervous, we engage in less of that activity. Being aware of the China meltdown (their stocks went down 23% in January), ISIS activities unsettling the Mideast, the Zika virus unsettling travel to the Olympics, and even the unusual uncertainties of our own Presidential race have heightened uncertainly. You don’t have to be an economist to know the stock market has been jumping up and down with lots of 200-300 point swing days. That’s simple nervousness, not fundamentals.
Lest we hang our collective heads, make no mistake there is a beauty to this beast. When international economies do well, we will also participate. Should India’s 1.277 Billion people inevitably rise to middle class and buy more Colgate toothpaste, our local smiles will widen. When dollar currency climb turns around (things generally go in cycles), international earnings count more. There are pains to our worldly interconnectedness, but the benefits are far greater.
[i] “Wild January Ends On A High Note” (Matt Egan, Money.CNN.com January 31, 2016)
[ii]“The Global Slowdown Hits the U.S.” (Ruchir Sharma, WSJ Opinion, January 13, 2016)
[iii] “Strond Dollar Batters Tech Firms” (Don Clark, et al, WSJ Business and Tech, February 1, 2016)