Union Pacific Corp. might not look like the most dynamic part of the U.S. economy. It has been hauling freight west of Chicago and New Orleans using rails first laid down in the 1860s.
But investors can’t get enough: The shares have surged nearly 24 per cent this year, to record highs. More importantly, the railroad symbolizes a fascination with companies that generate the vast bulk of their revenues on U.S. soil, countering the idea that expansion abroad is the only route to success.
While it’s only natural for investors to focus on a firm’s ability to grow its earnings and sales, the big money is being made by investors who look at where those dollars are being generated – and the U.S. is the current favourite.
According to Thomson Reuters, U.S. companies that generate a high percentage of their revenues on domestic soil have seen their share prices outperform the benchmark S&P 500 stock index.
The difference is a substantial 3 percentage points so far in 2013, and the difference stretches to a massive 10 percentage points over the past two years.
This helps explain a bizarre stock market pattern that has been intriguing observers for some time: Economically defensive stocks have outperformed cyclical stocks, amid an ongoing bull market that has sent the S&P 500 to record heights.
Bull markets are usually associated with cyclical stocks, so the defensive charge has fed a number of theories: Investors remain cautious, fearing another economic decline and bear market; or, they’re obsessed with dividend-paying stocks because bond yields are low – and defensive stocks on average have larger dividend yields.
But the idea that the difference between cyclical and defensive stocks has more to do with geography offers a fascinating alternative explanation – and one that John Kozey, a senior analyst at Thomson Reuters, believes will persist.
“As long as the U.S. shows stronger signs of recovery than China and Europe, investors should probably look at stocks whose revenues come mostly from within the USA,” he said in a note.
For his analysis, he looked at companies that earn at least 95 per cent of their revenues in the United States – a group of 150 names within the S&P 500 that he calls “sold in the USA stocks.”
They include Verizon Communication Inc., Altria Group Inc., UnitedHealth Group Inc., Southwest Airlines Co. and of course Union Pacific – generally stodgy companies operating in mature industries, largely without any designs on expanding into vibrant new markets.
And investors love them for it. Over the past two years (through May 1), these stocks have returned 31 per cent, versus 21 per cent for the benchmark S&P 500.
For sure, dividends are playing a role here. As Mr. Kozey points out, companies with revenues tied to the U.S. market have average dividend yields of 2.7 per cent, considerably higher than the 2 per cent yield on the S&P 500.
But the economic argument is far more intriguing, and likely acting as a stronger push. The U.S. economy is hardly booming – gross domestic product grew just 2.5 per cent in the first quarter, at an annual pace – but it looks more promising than other major markets.
The euro zone is in recession and looks set to remain there through 2013.
China’s economy grew 7.7 per cent in the first quarter. But that is well below growth seen during most of the past decade, raising concerns about an ugly slowdown there.
These economic differences make the United States look like a haven by comparison, especially with the country’s monthly payrolls rising at a nice clip and the housing market showing steady improvement.
As a result, stocks with a high percentage of U.S. revenues have stronger estimated earnings and revenue growth forecasts than the S&P 500.
The question now is how long these stocks can continue to beat the broader market, especially with sectors like consumer staples trading at historically high valuations.
Stocks with high U.S. revenues have underperformed since the third week of April – perhaps with Apple Inc. rejuvenating interest in tech stocks when it announced a bigger dividend, or perhaps with money flowing out of gold and into stocks.
But Mr. Kozey isn’t so sure that a sputtering rally over the past few weeks marks the end.
“There is still a penchant for safety,” Mr. Kozey said in an interview. “And the fact that we have just seen a wonderful move up in defensive sectors, and they’re now kind of resting for a few weeks, doesn’t necessarily mean the party is over.”