It’s easy to forget—and important to remember—that half the revenues of companies in the S&P 500 come from outside the U.S.
This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Deborah Frame, vice president of investments at Toronto-based Cougar Global Investments.
Much attention has been paid to the announcement that Canadian donut chain Tim Hortons agreed to be bought by the company that owns Burger King in a deal that could create the world’s third-largest fast-food company.
Burger King has said the acquisition was designed to expand sales, but much of the coverage suggests Burger King’s primary objective is to gain a tax advantage by shifting headquarters of the merged entity to Canada, where the corporate tax rate is 26 percent compared with 35 percent in the U.S.
Wherever the new company ends up being based, this proposed transaction reminds us that you don’t have to take money out of your U.S. stock index funds to get more international exposure. With investment markets becoming increasingly globalized, it’s important that big and popular funds like the SPDR S&P 500 ETF (SPY | A-98) have a truly international flavor.
Although foreign-based firms were deleted from the S&P 500 Index in 2002, this did not render the index a pure U.S. play. Today U.S. companies conduct almost as much business overseas as they do in the U.S. Close to 50 percent of production, sales and profits are from overseas business, and the amount paid in foreign taxes has been more than the amount paid in U.S. taxes in some recent years.
And it’s not just SPY that has an international flavor. The SPDR MidCap 400 ETF (MDY | A-79) does as well, and so does the iShares Core S&P Small-Cap ETF (IJR | A-91). At Cougar Global, we favor the S&P indexes and the funds built around them because we judge them to be the most viable way to achieve our asset allocation objectives.
Taking Measure Of Foreign Sales
The Financial Accounting Standards Board requires companies to disclose any geographic segment contributing 10 percent or more of revenues. The end result is that almost half of the S&P 500 issues are not required to report full information on the geographic segments contributing to their revenues, meaning they don’t have to provide a full picture of their global sales.
Although the U.S. is still the world’s largest single-country market, in recent times it has been a slow-growth market compared with much of the rest of the world.
Globalization has been an enormous boon for some of the biggest names in corporate America, and multinationals have increasingly followed global growth.
Foreign exposure allows U.S.-based companies to capitalize on rapid growth in emerging markets like China, India and Latin America, and earn much stronger profits than if they were totally dependent on the U.S. economy.
One reason that the U.S. stock market has been strong over the last two years is that despite lackluster growth in the big economies of the U.S. and Europe, the S&P 500 Index, by dint of its global exposure, continues to reflect relatively strong growth internationally relative to growth in the U.S.
Foreign Sales On An Upswing
So, just how much foreign exposure do we have in the S&P 500, 400 and 600?
Results for 2012 show S&P 500 companies reported foreign sales as a percentage of total sales increased to 46.6 percent after three-consecutive years of declines. By comparison, foreign sales were at 47.9 percent in 2008. Just a decade ago, foreign sales were in the 30 percent range, according to data collected by the U.S. Bureau of Economic Analysis.
A breakdown geographically shows that Asian sales increased to 7.5 percent of all sales, up from 7.2 percent in 2011 and 6.1 percent in 2010.
Offsetting this increase, European sales declined to 9.7 percent of all S&P 500 sales compared with 11.1 percent in 2011 and 13.5 percent in 2010; U.K. representation declined to 1.7 percent from 2.4 percent in 2011; and European ex-U.K. sales declined to 8.0 percent, from 8.7 percent in 2011 and 12.0 percent in 2010. Canadian sales declined to 4.1 percent of all sales from 4.3 percent in 2011.
Foreign Sales By Sector And Size
On a sector basis, information technology continued to dominate the foreign component in 2012 in the S&P 500, with foreign sales at 58.3 percent, 56.5 percent in 2011 and 56.3 percent in 2010. The sector now represents 16.2 percent of all U.S. foreign sales.
Data from 2010 show that nine information technology companies had foreign sales in excess of 85 percent of all their sales, with Texas Instruments reporting 89 percent overseas sales and Qualcomm reporting 95 percent.
As noted, S&P MidCap 400 companies also have exposure to foreign sales, though less than S&P 500 firms, and companies in the S&P SmallCap 600 issues have foreign exposure as well, though less than those in the S&P MidCap 400. Among the reporting small-cap companies, 39 percent of all sales were produced and sold outside of the U.S., compared with 39.4 percent in 2011 and 37.5 percent in 2010.
Small-cap regional data show that European sales continued to increase, representing 9.3 percent of all S&P Small Cap 600 sales in 2012, up from 8.9 percent in 2011 and 8.68 percent in 2010. Small-cap Asian sales decreased, representing 9.1 percent of all sales, down from 9.4 percent in 2011, after increasing from 8.4 percent 2010. European sales ex-U.K. accounted for 7.3 percent, up from 7.2 percent in 2011 and 7.1 percent in 2010.
Consumer staples continued to be the most successful (and exposed) sector in terms of foreign sales. In 2012, 52.5 percent of its declared sales were foreign, up from 48.1 percent in 2011 and 45.9 percent in 2010.
Taxes As Motivation
It’s tempting to think that tax abatement—as is being suggested in the Burger King-Hortons deal—is a driving force behind the internationalization of indexes like the S&P. But I don’t think it’s as big a driver as many think. Logic has it that higher foreign sales and earnings lead to higher foreign taxes. Not so quick.
Foreign sales may have increased in 2012 from 2011, but the shift in regional contributions changed the foreign tax paid. Asian sales continued to grow, while European sales continued to decline.
That shift resulted in S&P 500 multinationals sending more—not less—to Washington in 2012 than they sent abroad. They sent 51.2 percent to Washington in 2012 compared with 45.3 percent in 2011. This is a reversal because as recently as 2010, U.S. corporations were paying about $16 billion more in foreign tax than they were in U.S. income tax.
EM Access Via Multinationals
Accessing emerging market exposure through developed-market multinational companies is becoming an increasingly popular line of research for those looking to take a more directed approach to this idea. Indeed, a select group of developed-market companies have a heightened exposure to emerging market revenues.
Emerging markets accounted for 38 percent of total global gross domestic product in 2012 and 76 cents of every dollar in global GDP growth in 2011, according to data compiled by both the International Monetary Fund and BofA Merrill Lynch Global Research, 2011.
And though S&P 500 companies derived 46 percent of their total sales from foreign markets, only 14 percent came from emerging markets, according to data from S&P Dow Jones Indices data and BofA Merrill Lynch.
Appropriately enough, there’s even an index that targets the emerging markets explicitly through firms based in the developed world. That’s the EGAI Developed Markets Blue Chip EM Access Index. It’s an equally weighted index that includes a sector diversification screen for the 44 stocks from which the top 30 stocks are ranked by percentage of emerging market revenue.
There’s now an ETF on the market that was built around this index, the EGShares Blue Chip ETF (BCHP). So, to the list of well-traveled ETFs such as SPY, MDY and IJR that offer investors varying amounts of foreign exposure through companies based in the developed world, we can add BCHP as a newer way to mine this underappreciated method of obtaining foreign exposure.
At the time this article was published, Cougar owned shares of SPY, MDY and IJR on behalf of clients.
Cougar Global Investments, founded by Dr. James Breech, is a Toronto-based global tactical ETF portfolio strategist that uses only ETFs in its top-down global asset allocating strategies. Breech launched Cougar in 1993 around a downside risk management system he created. Contact Cougar Global at 800-387-3779 or [email protected].
Deborah Frame is vice president of Investments and chief compliance officer at Cougar. She heads up the research team there, including macroeconomic, market environment and asset class correlation research used in the firm’s qualitative and quantitative asset allocation models that focus on downside risk optimization and the use of ETFs.