FEBRUARY 2017 Monthly Market Insight Where Do Global Equity Revenues Come From? ALTHOUGH GLOBAL MACRO RISKS ARE TOP OF MIND THESE DAYS, MANY INVESTORS ARE UNAWARE OF THE EXTENT TO WHICH POLITICAL OR ECONOMIC TROUBLE IN OTHER PARTS OF THE WORLD COULD AFFECT THEIR EQUITY HOLDINGS. When I decide whether or not to favor a particular regional equity market, I always factor in its exposure to other regions. This sheds light on where companies earn their money, which markets they depend on, and, by extension, how much of their risk lies abroad. This month, I will delve into sources of revenues for US, an, ese, and emerging-market (EM) equity markets, and explore how their relative exposures shape my investment views. Investors may conclude that if the market exposure for a particular region s equity market involves unwanted risks, investing in an actively managed approach may be preferable to passive options, such as exchange-traded funds (ETFs). FIGURE 1 US equity market revenue sources 6% MSCI USA Index 1 12% When I decide whether or not to favor a particular regional equity market, I always factor in its exposure to other regions. Nanette Abuhoff Jacobson Nanette Abuhoff Jacobson Managing Director and Multi-Asset Strategist at Wellington Management Company LLP (WMC) and Global Investment Strategist for Hartford Funds Other 4% 12% 63% 3% 1 The MSCI USA Index is designed to measure the performance of large and mid cap segments of the US market. The index covers approximately 85% of the free floatadjusted market capitalization in the US. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE 1
: Revenues largely domestically driven I expect the US economy to continue to demonstrate the most strength among developed markets. The US equity market, as measured by the MSCI USA Index, is most insulated from global risk, as 63% of revenues are domestically driven (FIGURE 1). The US also has the lowest revenue exposure to among developed equity markets. Financials alone, which comprise 15% of the US equity index, as measured by MSCI USA Index, derive 75% of their revenues from the US. This is important because I expect that US financials will benefit from higher interest rates and looser regulatory conditions. Consumer discretionary, another large, domestically driven sector, should benefit from strong wage growth and increasing consumer confidence. Here though, I am watching the risk that protectionist trade policies could hurt the US auto industry, a major component of the sector that depends largely on its supply chain from. Continued strength in the US dollar, which will make exports more expensive, could be a drag on sectors that generate a significant portion of their revenue from overseas. But again, revenues from abroad account for just 37% of the US total, and only 18% come from EMs, which may suffer from increased protectionism. US sectors with the most revenue exposure to EMs are consumer staples, information technology, and materials. : Significant exposure to EMs FIGURE 2 an equity market revenue sources MSCI Index 2 7% 20% 20% 3% Other 5% 45% 2 The MSCI Index captures large and mid cap representation across 15 countries in. The index covers approximately 85% of the free float-adjusted market capitalization across the an equity universe. The an equity market, as measured by the MSCI Index, derives the majority of its revenues from outside of, with 27% of total revenues coming from EMs, including (FIGURE 2). Of all the developed equity markets, an equities have the largest exposure to EMs, making them more vulnerable to downside risk in these regions. This is a key reason why I am less favorable on than on the US or. Domestically, the an economic cycle is improving but rising off of a low base, with unemployment still at almost 10%. I expect volatility stemming from the uncertain political environment to continue, particularly in France and Italy. Sizable sectors of the an equity market with significant non-an revenue exposure include health care, consumer staples, and industrials. 2
: Foreign revenue drivers are a positive FIGURE 3 ese equity market revenue sources MSCI Index 3 Other 4% 7% 7% 9% 14% 59% 3 The MSCI Index is designed to measure the performance of large and mid cap segments of the ese market. The index covers approximately 85% of the free floatadjusted market capitalization in. Like the US, ese equities, as measured by the MSCI Index, are largely domestically driven (FIGURE 3). But unlike the US, large exposure to foreign revenue sources is a positive for, since I expect the currency to weaken over the next year due in part to aggressive monetary policy. A related plus is that just 16% of this non-domestic revenue exposure is from EMs and. ese large caps (namely consumer discretionary and industrials) should do particularly well, as these export-oriented businesses can benefit from a weaker yen. 3
markets: Revenues driven primarily by other EMs FIGURE 4 markets equity revenue sources MSCI Index 4 8% 2% 6% Other 10% 45% 29% 4 The MSCI (EM) Index captures large and mid cap representation across 23 EM countries. The index covers approximately 85% of the free floatadjusted market capitalization in each country. markets, as measured by the MSCI Index, main source of revenue is other emerging markets: 74% of revenue exposure is from EMs and, of which almost 40% is from (FIGURE 4). This makes me cautious on EM equities because of the headwind from a stronger US dollar and rising US yields (which could dampen capital flows to EMs). US protectionism is likely to hurt EM exporters as well. Mexico and are critical supply chains to the US auto and technology industries so US tariffs (the essence of House Republicans border-adjusted tax ) could be damaging to those countries in particular. It is important, however, not to paint all EMs with the same brush; differentiation is key. For example, countries with large current-account deficits import more than they export, and are dependent on foreign funding as a result. These debts become more expensive when the local currency weakens relative to the US dollar and the currencies of other major funding sources. Turkey, for instance, has a large current-account deficit and its terms of trade have weakened in the face of higher oil prices (Turkey imports its oil), putting these equities in a precarious situation. In contrast, Russia, a major oil producer, enjoys a budget surplus and rising commodity prices have improved its terms of trade, rendering Russian equities more attractive. 4
Investment Implications: Investors should understand the nondomestic revenue exposure in their equity allocations. I favor US equities as revenues are mostly earned in the US, the world s strongest economy. US financials are most exposed to domestic revenues and are poised to benefit from rising interest rates. I am neutral for now on an equities, because they have significant exposure to EMs and euro-area growth is weaker than that of the US. Focus on sectors with attractive valuations, like health care, or those that will benefit from a weaker euro, like consumer staples and industrials. If EMs hold up better than expected, an equities could b e n e fi t. I favor ese equities overall, and large caps in particular, for their relatively small EM exposure and because significant revenues from developed markets are positive, given the prospect of a weakening yen. EM equity exposure is all about differentiation. Politics, macro policies, economic drivers, terms of trade, and debt dynamics are all important and vary greatly from country to country. The views expressed here are those of Nanette Abuhoff Jacobson. They should not be construed as investment advice. They are based on available information and are subject to change without notice. Portfolio positioning is at the discretion of the individual portfolio management teams; individual portfolio management teams and different fund sub-advisers may hold different views and may make different investment decisions for different clients or portfolios. This material and/or its contents are current as of the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management or Hartford Funds. 5
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