Thought of the Week

1. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser.
Thought for the Week (283):
The World Economy
Synopsis
 The S&P 500 equity index is often used as a gauge for the overall health of U.S. equities, however, the index is much more geographically diverse than most investors realize.
 Emerging markets have been whipsawed over the last 2-3 years due to central bank policy in the U.S. rather than their own.
 These two facts support the continued trend of globalization, the idea that economies are becoming more “open”, and investors should acknowledge this “world economy” in order to profit.
The S&P 500 Index
The S&P 500 equity index is regarded as the de facto barometer for the U.S. equity market and often a proxy for the health of the U.S. economy. The index focuses on the large-cap sector of the market, and companies that are chosen for inclusion typically represent the leaders within their respective industries.
Over the past two decades, the companies that comprise the index have uniformly diversified their revenues by first increasing exposure to Europe, Middle East, and Africa (EMEA). Then, China’s surge to become an economic powerhouse diversified revenues even further as they ventured into much of Asia.
The chart below shows the regional breakdown of revenues for the S&P 500 as of the end of 2012:
NOTE: The chart above represents a best estimate, given the data available. Not all companies in the index report revenue by region.

2. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser.
The revenue breakdown above shows that approximately 66% of sales represented in the index originate from within our borders – hardly a true representation of the U.S. economy!
Taking this analysis a step further, the table below lists the companies with the largest revenue exposure to Europe, Middle East, and Africa (often this region is bundled together but given Europe’s dominance, most investors consider the EMEA region to mostly represent Europe).
Top 10 S&P 500 Constituents Based on EMEA Exposure
Ticker
Company
% Sales from EMEA
Market Cap (billions)
PM
PHILIP MORRIS
54%
$133
SLB
SCHLUMBERGER
50%
$115
IBM
IBM
30%
$204
GILD
GILEAD SCIENCES
30%
$113
FB
FACEBOOK
29%
$148
MRK
MERCK
27%
$145
BA
BOEING
27%
$106
GE
GENERAL ELECTRIC
27%
$275
JNJ
JOHNSON & JOHNSON
25%
$266
CSCO
CISCO SYSTEMS
25%
$119
This table indicates that some of the largest companies in the world derive up to 50% of their sales from EMEA alone. If we were to compare these data to two or three decades ago, we would see a material rise in the geographic diversification of revenues.
The primary driver of this trend has been a reduction in government protectionism in various countries, particularly emerging markets, in conjunction with technology driving down the cost of doing business. In doing so, economies are becoming more open, and subsequently, facilitating more trade.
Although we strongly support open economies, investors must increasingly pay attention to the events transpiring outside the U.S. that could potentially impact companies listed on U.S. exchanges. For example, consider how disconcerting Europe’s recent recession must have been to investors with large positions in the companies above.
Emerging Markets & The Fed
The Fed’s “War on Seniors and Savers” has pushed interest rates to historic lows over the past 18 months. Given such lackluster returns in U.S. government and corporate bonds, investors began to funnel cash not only into U.S. equities, but also investments in emerging markets in search of a higher rate of return.
As a result, emerging markets quickly became a “crowded trade”, or one where a very large group of investors act identically until asset prices inflate to the point where they can barely go further. Situations like these carry substantial downside risk to investors who are either “late to the party” or stay invested too long.
The chart below shows what happened to this crowded trade:

3. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser.
The chart above tracks the price action for the MSCI Emerging Markets index (MXEF) in 2013. Back in late May through mid June, the index sold off steeply because investors were spooked over fears that the Fed may begin tapering their Quantitative Easing (QE) bond-buying program unexpectedly.
Investors, who sought emerging markets for their once attractive yields, began selling as U.S. interest rates started to rise. As the gap between U.S. and emerging markets’ interest rates began to close, the risk-return profile began to favor the U.S. (due to its risk-free status), and emerging markets felt the brunt of investors running for the exits.
The impact on many of these emerging economies was quite severe, in some instances even forcing their own central banks to attempt to stabilize their currencies and markets. We find it noteworthy that U.S. Fed policy has the ability to impact markets across the globe, and this phenomenon is just another example of our continued shift to a world economy.
The bottom line is that our society will most likely continue to move closer to a world economy. Therefore, investors will also need to expand their analysis to include a more global perspective in order to properly assess how trends worldwide will impact their forecasts and security selections.