Different U.S. And European Economic Policies Have Implications For What Stocks To Own

by: Northrop Puckett


Two roads diverged in a wood and I - I took the one less traveled by, and that has made all the difference. -- Robert Frost

That Robert Frost quote reminds me of the way the U.S. and Europe have dealt with their debt and financial crises. The U.S. chose to use its Monetarist/Keynesian hybrid to try to grow its way out of the problem. This hybrid represents the two common modern economics theories. The Europeans, have adopted a more Monetarist/Austrian Economics-based policy. (I won't argue which method is better in the long run. I'm only mentioning these policies to illustrate short-term declines in Euro GDPs.)

The Monetarist component of the equation, which both central banks have instituted, is the Milton Friedman-developed idea that the cause of deep recessions or depressions comes from inadequate money supply during liquidity crunches. This is the stated reason that these two central banks have raised their monetary bases so much in the past four years. Again, one can question the extent of this monetizing, but providing liquidity is the stated purpose.

The Keynesian approach states that the government should increase spending during a recession to fill the gap left by lower private industry demand. While the government's implementation of this idea can be questioned -- after all, Keynes only recommended running a deficit during a recession, not in boom times too -- that is essentially what the Recovery Act was designed to do.

While the monetary responses have been similar in intent, the European fiscal response has been to cut spending drastically. Whether this is because European countries believe it is the best method to fix things, or whether there is a resistance to spend money to help another fiscally irresponsible country doesn't matter. What matters is what this means for the next couple of months.

The results in the near term are pretty predictable. The cuts to government spending were so severe that they sucked demand for goods and services from European economies. This has resulted in lower economic numbers and higher unemployment, especially in the countries that have enacted the cuts. The U.S. meanwhile has added to its debt, but slowly grown its economy and lowered its unemployment.

The uncertainty comes in the long-term time frame. Will the European economies stabilize, or will they enter a Deflationary Spiral? Can the U.S. Federal Reserve successfully exit its asset purchasing programs without causing rates to spike, or causing the U.S. to re-enter a recession? Additionally, the U.S. also faces sequester cuts now, which could have results similar to the European cuts. There is a lot that could happen globally that may change this picture. But let's look at some of the information we do have.


The chart below shows the continuing rise in European unemployment, and the overall decline in U.S. exports last fall. The European exports began declining last Spring. That wasn't really a surprise considering all of the fiscal austerity efforts that took place.

What's more interesting are the declines in exports to Asia, South America, and Africa, which haven't seen the same level of spending cuts as Europe has. It's not clear how much of this is due to a stronger dollar, or weaker foreign demand. Both factors are likely playing a role. Either way, it means less sales to foreign countries.

If you believe Chinese reported data, it has not experienced too much of an economic decline and is poised to continue into the proverbial "soft landing." But the above indicates that demand is weaker in China and other Asian countries.

So can you count on China to provide accurate statistics about its economy? If you look at the chart below, the Chinese GDP growth looks abnormally "even" compared with Europe GDP. There are no down quarters, or "hiccups" at all. Can you trust the numbers then?

Additionally, commodities and specifically copper, act as the canary in the coal mine with regard to global economic health. And China is a huge consumer of copper. If you believe the chart above, you would think that China is continuing to grow steadily and copper remains relatively strong, or is at least stable. But as you can see in the chart below, it is not, especially over the last three weeks.

So exports decreased across the board last quarter. Unemployment in Europe continues its rise. And demand for copper has fallen a lot recently. That could be a sign that the world economy is slowing rapidly. Is there anything else to look at? The Russell/S&P performance is interesting.

The Russell 2000 has gained more than the S&P 500 since December. Because the Russell comprises more small and mid-sized stock than the S&P, the Russell stocks get 19% of their revenues from overseas. The S&P 500 companies are larger and frequently multi-nationals, getting 46% of revenue from overseas. Is it possible that the market sees these foreign derived revenues continuing to decline and affecting the U.S. company earnings on the S&P more than on the Russell? It is possible.

Is there any evidence to corroborate that theory about the Russell outperforming the S&P because of exposure to foreign markets? In the chart below you can see that S&P 500 companies -- the ones with all that exposure overseas -- have provided some pretty negative guidance compared with analyst predictions. This can be a reflection of the view of weakness in foreign sales.

Does domestic demand versus foreign demand even matter? Well, yes I think it does, but I'm sure everyone can also agree that the biggest driver in this market is the Federal Reserve. Note the correlations in the chart below.


What does it all mean? Based on the data available, the U.S. looks healthier than a lot of foreign markets, if only marginally and due to Federal Reserve stimulus. If the U.S. economy starts to significantly deteriorate due to sequestration -- it may -- then you adjust for that. But for now, our economy continues to grow and many foreign economies seem to be declining. This will have an effect on revenues derived overseas. Therefore, you could look to avoid companies that heavily depend on foreign markets.

Some of the largest exporters in the United States include: Dupont (DD), Dow (DOW), Exxon (NYSE:XOM) and Weyerhueser (NYSE:WY). Other companies with a significant portion of their revenue coming from overseas include General Electric (NYSE:GE), Caterpillar (NYSE:CAT), McDonald's (NYSE:MCD) and Intel (NASDAQ:INTC), to name a few.

If you are looking for companies without a lot of exposure to foreign markets, it makes sense to look at small and mid-cap stocks. They are more likely to get their income domestically. You should read their annual reports to make sure that is the case though. If you are prefer large-cap companies, U.S. utilities are one area to look at. So are the health insurance and hospital management companies -- like UnitedHealth Group (NYSE:UNH) -- which also tend to get most of their income from the American market.

Disclaimer: We do not know your personal financial situation, so the information contained in this article represents my opinion, and should not be construed as personalized investment advice. Past performance is no guarantee of future results. Do your own research on individual issues.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.