How much of a headwind is international exposure causing US-based companies? Factset did a study earlier this month, drawing on a combination of companies that had already reported Q3 earnings and used estimated results for those who had not reported.
It sheds light on the much-discussed earnings recession. The blended earnings (as of November 5) of S&P 500 companies in Q3 15 declined by 2.2%. For companies that earn over half of the their income in the US reported a 4.8% rise in earnings. Those that generate more than half their sales abroad reported a loss of 10.6%.
Overall sales fell 3.7% in Q3. Domestic-oriented companies, sales rose 1%. The more international companies reported a 12.5% decline in sales. However, the performance has been exaggerated by the dramatic weakness of the energy sector.
What if the energy sector was excluded? Then the S&P 500 earnings growth would have been 4.5%. Domestic-oriented companies , the blended earnings in Q3 rose 10.1%. International-oriented companies experienced a 2.1% decline in blended earnings.
Excluding energy, the blended sales growth of the S&P 500 was a meager 1.4%. Domestic-oriented companies reported a 4.7% increase in sales, while the multinationals reported a 4.9% decline.
There are two potential explanatory variables, foreign exchange and demand. Most observers tend to emphasis the appreciation of the dollar. While there may be an kernel of truth here, it is important not to exaggerate it. First, although the US is the world’s third largest exporter, US companies service foreign demand primarily by building locally and selling locally. This is to say that for various historical reasons, US companies pursued a direct investment strategy rather than the classic export-driven path, like Germany, Switzerland, and China.
The sales by majority-owned affiliates of US companies outstrip exports by a factor of more than four. One thing that this means is that US companies incur costs in foreign currencies not just revenue. The local wage bill, some times components and other inputs, as well as marketing and storage and transport. Dollar appreciation reduces the dollar value of foreign earnings but it also cuts the dollar value of those labor and other input costs.
The second explanatory variable for the poorer results from US-based multinational companies is the weaker global economic climate. Although growth in the eurozone has been fairly steady around 0.4% for several quarters, domestic demand remains weak, weighed down by high unemployment. Japan contracted in Q3. China is slowing. Canada contracted for the first five months of the year before snapping back in June. Thus far the recovery is unremarkable
Although the foreign exchange factor is intuitively clear, and there is some evidence, the more important consideration is demand. This has been borne out in numerous academic studies. The best thing for US exports and foreign sales, more broadly, is stronger demand.