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
|Mexico and Latin America||3.04%|
|Middle East and Africa||1.22%|
1 National Center for the Middle Market, 1Q 2016 Middle Market Indicator. The National Center for the Middle Market defines the middle market as U.S. companies having annual revenues from $10 million to $1 billion.
2 Steve Goldstein, “S&P 500 companies generate barely over half their revenue at home,” MarketWatch, August 19, 2015, http://www.marketwatch.com/story/sp-500-companies-generate-barely-over-half-their-revenue-at-home-2015-08-19.
3 Sam Ro, “Here’s how much business S&P 500 companies do outside of the US,” Business Insider, July 9, 2015, http://www.businessinsider.com/foreign-revenues-by-region-2015-7.
4 U.S. Broad Trade-Weighted Dollar Index, Federal Reserve.
5 Euro Area Business Cycle Dating Committee, Eurostat.
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