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Comfortably insulated

Britain’s vote to exit the EU has caught markets wrong-footed. We saw firsthand the negative effects of the overhang of macro events earlier this year – China’s slowing growth, falling oil prices and Federal Reserve policy speculation.

Lara Rhame
June 24, 2016 | 2 minute read

Britain’s vote to exit from the European Union has caught markets wrong-footed. We saw firsthand the negative effects of the overhang of macro events earlier this year – China’s slowing growth, falling oil prices and Federal Reserve policy speculation. Yet for all of the global market volatility, we believe the U.S. middle market is largely insulated from international economic events.

Middle market companies report that they generated 87% of their revenue domestically in 2015.¹ This is in sharp contrast to many large public companies, which have complex international supply and distribution networks that leave them more exposed to the non-U.S. business cycle and the exchange rate. Two estimates show S&P 500 companies earn between 52%² and 67%³ of revenue from the U.S.

For the 13% of U.S. middle market revenues earned abroad during the first quarter of 2016, the sources of revenue are spread around the world. This minimizes the potential negative impact of a growth slowdown in any one region. During the same period, 3.0% of middle market revenues came from Europe, 2.7% from Canada and 2.5% from Asia.¹ In short, even though China receives significant coverage in the headlines, the direct impact to the bottom line of middle market companies appears minimal.

Looking ahead, several international uncertainties loom for investors. One concern is the exchange rate of the dollar, where a strong dollar can handicap U.S. industry. The dollar hit its high-water mark in January,⁴ and, despite significant monetary policy easing in Europe and Japan, has actually retrenched somewhat. While I and other analysts don’t expect the dollar to strengthen much more from these levels, it’s still a good time to be seeking some insulation from exchange-rate volatility.

Another concern is foreign growth prospects. While extensive European Central Bank easing has helped EU growth accelerate modestly after its 2011–2013 recession,⁵ headway in Japan has been more elusive. China has promised further fiscal stimulus to bolster its economy; however, the health of China’s economy remains a concern for U.S. policymakers and investors. Here, again, diversifying into areas that are more insulated from the foreign business cycle is a wise move. Looking ahead in 2016, international events may well spark uncertainty, making insulation extremely valuable.

Sources of U.S. middle market revenue by region:1

Europe3.05%
Mexico and Latin America   3.04%
Canada2.68%
Asia2.52%
Middle East and Africa1.22%

This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. FS Investments is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All views, opinions and positions expressed herein are that of the author and do not necessarily reflect the views, opinions or positions of FS Investments. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. FS Investments does not provide legal or tax advice and the information herein should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact any investment result. FS Investments cannot guarantee that the information herein is accurate, complete, or timely. FS Investments makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.

Any projections, forecasts and estimates contained herein are based upon certain assumptions that the author considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. The inclusion of projections herein should not be regarded as a representation or guarantee regarding the reliability, accuracy or completeness of the information contained herein, and neither FS Investments nor the author are under any obligation to update or keep current such information.

All investing is subject to risk, including the possible loss of the money you invest.

Lara Rhame

Chief U.S. Economist + Managing Director

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