November 21, 2016: International Exposure Of U.S. Large Companies

Nov 22, 2016 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

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For regular SAA and TAA portfolios, the next re-balance will be on Monday, November 28, 2016. You can also find the re-balance calendar for 2016 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

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International Exposure Of U.S. Large Companies

In previous newsletters, we alluded that multinational companies in the US have large international exposure in terms of their revenue and profitability. In this newsletter, we want to delve into this topic in more details and discuss its effect on asset allocation, especially in light of a Trump presidency.

S&P 500 companies international exposure

Depending on the methodology, it’s estimated that S&P 500 companies have more than 1/3 to 40% oversea revenue:

Factset’s data (as of 11/18/2016):

While S&P reported that in 2015, S&P 500 derived 44% of its revenue from foreign countries. Among this, European sales accounted for 7.8%, Asia 6.8% and 22% from a general foreign countries category (as many companies did not break down their foreign sales into more specific regions).

Among sectors, Factset data show that information technology, materials, energy and industrials are the most exposed to international sales, each deriving more than one third of their revenue from oversea. Information technology has more than half of foreign revenue (58%).

What the above data tell us is that for the 500 largest US companies, their oversea business exposure is substantial. Thus, their overall business can be materially affected by trade policies and currency exchange rates.

Impact from the Trump presidency

U.S. dollar exchange rates with other countries’ currencies are one of the main factors that can materially affect US multi-national companies’ sales. As U.S. dollar becomes more expensive, not only U.S. goods become more expensive in other countries’ local currency, the revenue and earnings earned in local currencies are also worth less in dollar’s term. Thus, the stronger U.S. dollar, the less companies will earn from oversea.

$DXY is a U.S. dollar index. At this moment, it has reached late 2002 level, notching more than 13 years’ high.

As the U.S. is posed to raise interest rates, U.S. dollar has been strengthening. President-elect Trump’s pro growth policies with much higher debt for infrastructure spending will only increase the inflation pressure, thus making U.S. dollar even higher .

The other important factor that could seriously affect companies’ international businesses is the U.S. (and other countries’) trade policies. If Trump’s anti-globalization and stricter trade policies (such as much higher import tariff) are implemented, one can expect global trades (and thus earnings from oversea) will decline substantially (depending on the extent these policies are actually carried out).

In general, we view the above development is likely to enter a secular phase.

Effect on asset allocation

The secular trend mentioned above will have impact on our Strategic Asset Allocation (SAA). If one simply invests in a U.S. large companies index such as S&P 500 (VFINX or SPY for example), you might already have much higher and undesired international exposure.

A couple of ways to cope with the increased foreign exposure.

For U.S. stocks, a more broad base index such as VTI (Vanguard Total Stock Market ETF) can be used instead of S&P 500 index. These broad base indexes have more exposure in small companies, which have much less foreign exposure. Or one can use style exposure to have large, mid cap and small cap companies index funds as candidate funds.
Adjust (decrease) overall allocation to other international stocks including developed countries’ stocks (such as VEA (Vanguard FTSE Developed Markets ETF) or VWO (Vanguard FTSE Emerging Markets ETF)). Regarding the timing of such adjustment, international stocks are relatively cheap compared with the U.S. stocks. However, assuming a smooth transition, the U.S. economy might continue to strengthen. We suspect these two factors will largely offset each other in a long period of time.
Consider using currency hedged ETFs for foreign stock exposure. For example, HEDJ (WisdomTree Europe Hedged Equity ETF) uses Euro vs. US dollar hedge.

Hedged vs. unhedged ETFs:

ETF	YTD Return**	1Yr AR	3Yr AR	5Yr AR	5Yr Sharpe
HEDJ (WisdomTree Europe Hedged Equity ETF)	1.6%	-5.3%	4.7%	10.6%	0.57
VGK (Vanguard FTSE Europe ETF)	-5.7%	-8.1%	-3.7%	5.7%	0.29

Market Overview

Investors continued to rotate out of bonds and gold. The ‘safest’ Treasury notes/bonds, mortgage back bonds and municipal bonds lost more than 1% last week. Furthermore, as US dollar continued to strengthen, international bonds and emerging market bonds lost. 30 year mortgage rate has shot up to one year high. We’ll just need to wait to see whether this abrupt turn of events will derail the economic growth. As always, we will stick to our strategies.

For more detailed asset trend scores, please refer to 360° Market Overview.

As now we have a president elect who promised to challenge the status quo and make substantial structural change (such as infrastructure building), we are now in a wait and see period: as the nation is posed to invest, the most important factor to watch is how productive the investments will be. Simply put, productive investments will result in better return on investment (ROI), tangibly or intangibly. They should also increase productivity that in turns will improve our standard of living. Capital misallocation can result in a higher growth but might not improve the real standard of living, which is the ultimate goal of economic activities.

In terms of investments, U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future.

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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