(Bloomberg Opinion) -- So far this year, the market has looked like late 2018, but in reverse. The stocks that did poorly late last year, like video streaming service Netflix Inc. and energy company Hess Corp., have done well in early 2019, and vice versa. Overall, the S&P 500 Index has climbed nearly 13 percent this year. Dan Suzuki, a portfolio strategist at Richard Bernstein Advisors, put it to me this way: “It’s as if the market woke up and realized it made a mistake and pushed the rewind button.”
That rewind, though, given all the macroeconomic indicators, is looking like a potential mistake. The biggest blunder investors could be making is with U.S. companies that make most of their money selling goods overseas.
For most of the S&P 500 companies, the first quarter is looking as if it will turn out worse by the day. Analysts now expect their bottom lines to drop by an average of just more than 3 percent in the first quarter compared with the period a year earlier, according to Bloomberg data. If that happens, it will be the first time that quarterly earnings have shrunk since mid-2016.
The reason has to do with companies in the S&P 500 that generate 50 percent or more of their sales overseas. The first quarter for those companies is projected to be particularly tough, with bottom lines dropping by as much as 11 percent, according to a recent study by John Butters, senior earnings analyst at FactSet. Exclude those companies, and the earnings of the S&P 500 would be up in the first quarter, though still only by 1 percent.
There are a number of reasons for the earnings divide. The biggest is the fact that while the U.S. economy appears to be slowing, it’s still stronger than the rest of the world economy. That, of course, plays to the strength of companies that derive most of their sales inside the United States. But also at play is the dollar, which has strengthened this year against other currencies, hurting the sales and earnings power of U.S. multinationals. Trade tensions have probably led to some drop-off in sales. Lastly, Suzuki notes that cyclical stocks tend to have the most foreign exposure, and it is those companies that experience the biggest drop when the economy starts to turn, as it may be doing now.
Investors, however, don’t seem to have absorbed this, at least if stock prices are any indication. Despite the large gap in earnings expectations, the valuations of the stocks that derive most of their sales overseas are nearly the same as those that are more domestically focused. The average stock in the S&P 500 Focused Foreign Revenue Exposure Index has a price-to-earnings ratio of just less than 17 based on this year’s expected earnings, essentially the same as where the entire S&P 500 is trading.
Part of what’s going on surely has to do with trade. Starting in early 2018, the stock market, and more specifically the stocks that make much of their money overseas, tumbled on news that President Donald Trump was going to impose tariffs on steel and later a broader array of goods from China. At the time, I said the drop was more than those shares deserved. Now that trade tensions are easing, those stocks have similarly risen more than they deserve. But evaluating the earnings potential of multinational companies based on tariffs is a backward way to look at this. Yes, trade relations do matter a lot to those companies’ futures. The potential growth is overseas. At the same time, though, the dollar and strength of emerging economies will matter much more than tariffs to the bottom line for the next year or so.
Investors should be careful about retracing their steps. The market path rarely stays the same for long.
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Stephen Gandel is a Bloomberg Opinion columnist covering banking and equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.
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