U.S. Stock Investors Can't Escape Foreign Worries

It's a sign of these globalized times when a debt crisis in a small European nation becomes a top concern of investors in U.S. stocks.

Talk to portfolio managers in the American heartland and they're as concerned as anyone about the credit woes of Greece, even if the nation's gross domestic product is a quarter the size of California's economy and makes up just 2.6% of the euro zone's gross domestic product.

"We're now in a much more globalized world," says Wasif Latif, vice-president of equity investments at USAA Investment Co. in San Antonio. "The impact of one event in one place in the world can ripple across all markets."

Good News at Home

Investors in U.S. stocks are paying close attention not only to Greece but to China, where the government has stepped in to slow an overheating economy, says Richard Sparks, equity analyst at Schaeffer's Investment Research in Cincinnati.

"The old phrase is 'the U.S. sneezes and the world catches a cold,' " Sparks says. "Now anyone sneezes and it can affect markets around the world."

Worrying foreign news has drowned out good news at home, Latif says.

Fourth-quarter earnings have arrived from 349 of 500 companies in the broad U.S. Standard & Poor's 500-stock index, and the index's earnings are up 46.8% year-over-year, 11.6% more than analysts surveyed by Bloomberg were expecting. The U.S. GDP grew 5.7% last quarter, according to advance data released Jan. 29.

U.S. stocks have declined along with—though not as severely as—stocks in the rest of the world. The S&P 500 is down 3.26% since the start of the year. The MSCI EAFE index, covering developed-market stocks outside North America, is down 7.3% this year, and the MSCI Emerging Markets index is off 7.4%.

Earnings from Abroad

Distant events are shaking U.S. stocks for both fundamental and psychological reasons, stock managers say.

Because much of their earnings come from abroad, many U.S. companies are now highly sensitive to foreign economic conditions or the swings of currency markets. A July 2009 analysis by Standard & Poor's showed foreign sales made up 47.9% of revenues at S&P 500 companies that disclosed such figures in 2008, up from 43.6% two years before.

Greece's woes are probably "insignificant to the larger economic picture," says Michael Cuggino, portfolio manager of the Permanent Portfolio Funds in San Francisco. "It bears watching," he says, because of the threat of "further contagion." Since the outbreak of the financial crisis more than two years ago, U.S. markets have become more susceptible to worldwide panic, he says.

Though Greece's debt load is particularly onerous, the governments of most developed economies also have run up big bills in recent years, says Keith Goddard, president and chief executive of Capital Advisors in Tulsa.

"Greece is a symptom of this much bigger problem," Goddard says. Thus, the outcome of the Greek debt crisis is a "near-term barometer" of governments' ability to control their fiscal situations without sparking market panics, he says.

Currency Effects

The key fundamental measure of stock value is corporate earnings, and "U.S. profits are now heavily leveraged to global growth," says Brad Thompson, fund manager at Frost Investment Advisors in San Antonio.

For example, currency markets can have a big effect on U.S. profits. Since Nov. 25, the U.S. dollar index, measuring the greenback against a basket of foreign currencies, is up 7.7%.

Currency swings are notoriously difficult to predict, but Bank of America Merrill Lynch (BAC) analysts predicted Feb. 8 that the dollar should continue to strengthen against developed economies, but weaken against emerging markets.

A stronger dollar can hurt foreign profits in significant ways. For a U.S. company that receives 50% of its sales and profits from abroad, a 10% rise in the dollar would cut profits 5%, Thompson notes. To reduce such risks, Thompson owns international companies that hedge their currency risks, like Google (GOOG).

The International Monetary Fund predicts the world economy will grow 3.9% in 2010. Emerging and developing economies are expected to grow 6%. According to the projections updated Jan. 26, the U.S. is expected to grow 2.7% this year, while the euro zone should grow 1%. "Emerging-market economies should remain healthier," says Goddard. That's why he owns a company like Procter & Gamble (PG), which last fiscal year made 61% of its sales outside the U.S. In the developed world, P&G's growth is limited. "What allows P&G to take its growth rate up a couple points is [that] the products they sell are way underpenetrated in emerging markets," Goddard says.

China Watch

Emerging-market economies have become key drivers of growth at companies seeing weak sales growth in the U.S. and Europe. On Feb. 11, PepsiCo (PEP) reported net revenue growth of 12% in Asia, the Middle East, and Africa. Its European operations and its Americas food division saw revenues rise 5%, while its Americas beverage unit saw sales dip 1%.

That's why many U.S. investors remain focused on China, the world's second-largest economy. China is "one of the only major growth engines in the global economy right now," says Les Sutlow, senior portfolio manager at Cabot Money Management in Salem, Mass. Economic troubles in China could directly hurt overseas results for U.S. companies, but they could also have an important psychological effect.

China is a "major driver of emerging-market sentiment," Sutlow says. A weaker China could frighten investors in Brazil, India, or other emerging economies.

"Confidence is still fragile," USAA's Latif says.

Against the backdrop of a more optimistic market, investors might shrug off the economic and fiscal hiccups in China and Greece. After the financial crisis and recession of the last three years, though, investors may not be so sanguine.

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