The strong U.S. dollar is not the only reason the country's economic data has disappointed, but Canadian investors would still do well to avoid U.S. stocks with high levels of international revenue.
In a recent speech, New York Federal Reserve President William Dudley noted his expectation that the strengthening greenback will cut U.S. economic growth by 0.6 per cent as "U.S. exports [become] more expensive and imports more competitive." The pain will be felt most acutely by multinational companies with the highest percentage of international sales.
The table below contains the S&P 500 companies with highest percentage of foreign revenue. Dow Chemical Co. tops the list with a surprisingly low 3.1 per cent of total revenue from the United States. McDonalds Corp., with 66 per cent of revenue from non-U.S. sources, and Aflac Inc., with almost ¾ of revenue from overseas were other surprises.
In the past twelve months, the U.S. trade weighted dollar index has climbed almost 18 per cent. As a result, American companies with overseas sales have seen revenues reduce by translation effects – the same amount of foreign currency is now worth less in U.S. dollar terms.
The chart suggests the stronger dollar is having a direct effect on market performance. The broader S&P 500 is outperforming the average return of the internationally-focused stocks from the table.
The performance of the Russell 2000 U.S. small cap index is likely the strongest evidence that the rising greenback is crimping profits for multinationals. Revenue for small cap stocks is almost entirely domestic, and foreign exchange is rarely a hurdle to profit growth. The Russell 2000's 5.0 per cent year-to-date return and 16.0-per-cent appreciation in the past six months has easily outdistanced both the S&P 500 and the list of companies generating the most revenue outside the U.S.
Canadian investors should avoid U.S. companies with high levels of international revenues wherever possible until the strong dollar trend ends. Domestically focused U.S. companies allow Canadian portfolio to benefit from dollar strength while avoiding currency translation effects.
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SOURCE: Scott Barlow/Bloomberg