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In a volatile year for the U.S. equity market, one factor has emerged as pivotal in determining whether a stock is likely to rise amid growing concerns over trade policy: how much of that company’s revenue is derived from domestic sources.
This distinction has proven to be a key issue for investors trying to determine what stocks will be most impacted by tariffs or other so-called protectionist policies. Some names could be more insulated from the issue. For others, the more global a company’s business, the more vulnerable it could be in this political environment.
This factor helps to explain a pronounced divergence in major U.S. stock-market indexes. The Dow Jones Industrial Average which is comprised almost exclusively of bellwether multinationals, is down 2.4% this week to date. Those losses pulled it back into negative territory for the year, down 0.9%.
In contrast, the Russell 2000 index of small-capitalization shares is up 0.5% thus far this week, and up 10.3% in 2018. While the Dow is on track for its eighth straight down session on Thursday, its longest losing streak since March 2017, the Russell closed at a record on Wednesday before joining in broader-market declines Thursday.
Much of the Dow’s weakness and the Russell’s strength has to do with how focused on the U.S. the components of the index are. According to FactSet, the Dow derives just 52.8% of its revenue from the U.S., meaning more is at risk from escalation trade tensions. In contrast, the Russell gets 78.6% of its revenue from the U.S., providing a bigger buffer against any escalation.
The iShares Russell 1000 Pure U.S. Revenue ETF , an exchange-traded fund tilted toward companies with a domestic focus, is up 2.5% thus far this month, outperforming the 1.9% gain of the S&P 500 over the same period.
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Within the Dow, the average’s global-focused stocks have lead recent declines. According to DataTrek Research, “international exposure is the common link between most of the big losers: 3M, Caterpillar, Procter & Gamble and Johnson & Johnson.”
Shares of 3M Co. are down 16.6% thus far this year, accounting for nearly a third of the Dow’s underperformance relative to the S&P 500 .
“Worth noting: 3M is one of the most international companies in the Dow, with just 39% of revenues coming from domestic sources,” wrote Nicholas Colas, DataTrek’s co-founder. Caterpillar derives 54% of its revenue from outside the U.S., while 55% of P&G’s sales originate outside the U.S. For Johnson & Johnson, 48% of revenue is generated from outside the U.S.
“As for Walmart, although its revenues are still 73% U.S.-based, much of what it sells is obviously made elsewhere,” Colas wrote.
Shares of Caterpillar are down 10.1% in 2018, while P&G has lost 16.6%, J&J has shed 12.9% and Walmart is off 14.5%.
Concerns that trade tensions could escalate into a full-on trade war increased this past week, after President Donald Trump threatened an additional $400 billion in tariffs against China. A spokesperson from China’s Ministry of Commerce said China would have no choice but to take comprehensive measures in response to the U.S.’s trade moves, the state-run Xinhua News Agency reported.
In another, somewhat related factor, multinationals also face pressure from a rising U.S. dollar, which can erode their overseas profits. The heavier U.S. focus of smaller stocks, in contrast, means they face less of a currency headwind. The U.S. Dollar index is up 5.1% since the start of April.