Pat Dorsey: Hi. I am Pat Dorsey, director of equity research at Morningstar. As most of you know, Morningstar is a bottom-up shop. We don't do a whole lot of big-picture, top-down predictions that this sector will do this, or the economy will do X, or interest rates will do Y and Z. We tend to look at things company by company and then see what kind of insights bubble up from that kind of approach.
However, it is sometimes interesting to take all the data and aggregate it and see what insights you can come up with. So with the help of one of Morningstar's crack interns, I have been compiling some data on the S&P 500, as a representative slice of the market, by region. And there are some interesting insights that come out from this.
So just to give you some background, what we did is we went through most of the companies in the S&P 500 to see how much of their revenue came from the U.S. versus coming from outside the U.S. Unfortunately, most companies don't really report net income geographically. They tend to just report it on a revenue line. And what I did is made sort of a big simplifying assumption and said that the proportion of revenue was going to be the same as the proportion of net income.
Now you can quibble with this, because for U.S. companies, cost structures may be higher abroad. Maybe operating margins are a little lower. However, corporate tax rates are a lot lower just about everywhere in the world outside the U.S., so my bet is, on balance, it kind of nets out. And you kind of have to look at this on a net income basis, because that is how people value companies. You can't look at it on a revenue basis. Otherwise, companies with 1% margins and massive revenue lines, like distributors, for example, kind of skew the data.
So, bottom line. What did we find when we went through all of the data? Well, interestingly, about 40% of the net income from the S&P 500 comes from outside the U.S. So even if you don't have a shred of international in your portfolio, which is probably not a good idea, you have quite a bit of foreign exposure. And if you happen to be overweight in certain sectors, you probably have even more.
If you look at the data, believe it or not, the tech sector gets over half of its earnings from outside the U.S. The energy sector gets over half its earnings from outside the U.S. Now this is largely because the supermajors, like Chevron and ExxonMobil, they comprise the bulk of the net income for energy and have lots and lots of production facilities and E&P operations outside the U.S.--very, very internationally exposed. On the other end of the spectrum, as you might expect, the consumer discretionary sector and the financial sector are much more heavily domestically based.
So it is kind of interesting, if you kind of jigger around with things. If you happen to not own much in the way of telecom or utilities, and you owned less financials than the 15% waiting in the market, you would be pretty darn close to a portfolio that is half-and-half, U.S. and foreign.
Now granted, having a portfolio of U.S. companies that are half exposed to foreign countries is not quite the same as owning foreign companies, because there are currency effects that you won't take into account, and companies tend to move up and down with their home markets, regardless of where they are actually the net income from.
However, it is kind of an interesting thing to think about, especially in the context of this statistic people often throw around of the U.S. consumer, flat on their back, perhaps getting up and crawling to the emergency room now, comprises about two thirds, about 66%, of U.S. GDP.
Well, here is the thing: We don't invest in GDP. We invest in companies. We invest in the S&P 500, where 40% of net income comes from outside the U.S., and the remaining 60%, again, only two thirds, comes from the U.S. consumer.
So, you know, it is very possible that corporate earnings may outpace U.S. GDP, simply because, well, corporate earnings aren't GDP. That corner dry cleaner who is not doing as much business right now, the corner cafe, they are private. You don't own those. Big multinational companies that produce wind turbines, like GE, or big pharmaceutical companies, they don't tend to be private. They tend to be public.
So those two groups, the domestic economy and the stock market, that you probably own in your portfolio, they're quite different. So again, I think it is a reason to, perhaps, sometimes cast some doubt on some of the conventional wisdom that is out there in thinking that if you own U.S. stocks, you own the U.S. economy. It is really not that simple, because, in fact, if you own U.S. stocks, about 40% of the net income coming into your portfolio is coming from outside the U.S.
I am Pat Dorsey and thanks for watching.