As investment analysts we always need to be aware of the current market environment and its impact on companies in our coverage lists. At times these factors can be easy to spot; however, this is not always the case.
Take today’s current environment. There has been more and more concern over what the slowdown in China will mean to earnings of companies trading on U.S. exchanges. I recall recently reading a piece in Barron’s, in which an economist argues that the country’s decelerating rate of growth will not be as material as some think. He stated that sales to Chinese companies made up a small percentage of the revenue generated by all the companies in the S&P 500, so its impact would be relatively benign. For a moment this calmed my own concern on the topic. However, as I thought more I began to ask myself other questions, such as:
- How will this impact other economies who are large trading partners with China?
- What percent of revenue and profit do these regions account for among companies in the S&P?
- How will this impact global currency values relative to the dollar?
- What does this mean for the Fed’s potential change in interest rate policy?
Looking at a chart of the largest global economies, it becomes obvious that troubles among the second largest tier could easily have much further reaching impacts than what would have appeared to be the case after reading that Barron’s article. This has already been a factor pushing Brazil, another top 10 global economy, into a recession as demand for its natural resources slows. Similar domino effects could be had on other areas of the world–if they haven’t already started—and would impact a larger percentage of S&P 500 revenue when accounting for sales to these nations as well.
These dynamics also impact currency values, where the overall trend recently has, of course, been appreciation of the dollar against the money of virtually all other nations. This could be further compounded by an increase in rates by the Fed as it would be one of the only central banks in the world raising rates. We have seen what a stronger dollar has done to sales and profits among U.S. multinationals over the past few quarters.
The list of potential impacts could go on, most of which are not as easy to spot as it may seem. This all circles back to doing your homework and continuously asking questions and looking for information that either supports or conflicts with our assumptions of profit growth among companies on our lists.
Is your investment department asking the right questions?
Indices are unmanaged and cannot be invested into directly.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.