One moment stock prices rejoice on bailout news for the eurozone… the next moment they collapse. Take Monday, for example-- Spain officially requested $125 billion from the European Union to shore up its banking system. "Plop, plop, fizz, fizz… oh what a relief it is…" Right? Or not!
Spanish stocks jumped 6.2% in early trading, only to reverse course and then close the day in negative territory. No doubt, the violent seesaw in prices is enough to keep any investor out of European investments. But steering clear of European stocks and bonds doesn't mean you're completely safe. In fact, your portfolio could be loaded with ticking time bombs, set to detonate once second-quarter earnings reporting season begins. Here's why…
Lost in Translation
As I noted on May 18, the U.S. dollar's feeling rather mighty again. How else do you describe a 5% rally over the last six weeks?
These gains, of course, aren't the result of robust economic data coming out of the United States. To the contrary, much of the relative strength can be attributed to the relative weakness in the euro. Since peaking in late February, the euro's down 7.2% in relation to the U.S. dollar.
Whether or not we invest directly in currencies, we need to be concerned about the latest developments. This is because U.S. companies don't book sales exclusively in the United States. They also book sales in international markets-- a meaningful amount. Case in point: Standard & Poor's estimates that 46% of revenue for the companies in the S&P 500 Index came from overseas in 2010. In some sectors, like technology and materials, more than 52% of sales came from overseas.
Since U.S. companies report results in U.S. dollars, they have to convert profits overseas into dollars at quarter's end. And if the currencies in those foreign markets depreciate against the dollar, like they're doing now, it cuts into profits. The greater the percentage of international sales, the greater the potential for foreign currency translation losses.
If you don't think international sales exposure can sap stock market returns, think again. According to Bespoke Investment Group, over the last year, stock prices for companies with at least 50% of sales from overseas fell 8.5%. Compare that to a 1.4% rise for companies with close to 100% of sales in the United States.
Here's the rub: We can't monitor foreign currency translation on a day-to-day basis. Instead, we only get updates on a quarterly basis when each company reports results. And with second-quarter earnings season rapidly approaching, it's time to reiterate my warning… Take the time to review your investments and check each company's SEC filings to find out what percentage of sales come from overseas. You might be surprised by what you find out, too. Not all American companies are really all that American. For instance, McDonald's (NYSE: MCD), Coca Cola (NYSE: KO) and Heinz (NYSE: HNZ) all generate more than 50% of their sales outside of the United States.
Bottom line: Weaker-than-expected fundamentals combined with foreign currency translation losses, could lead to a nasty slide for individual stocks headed into second-quarter earnings season. I suggest you check your holdings for these invisible risks before it's too late. Particularly, companies in the technology and materials sectors.
Disclosure: No positions