Historically, foreign markets have not moved U.S. markets -- until now, according to Robert Webb, professor of financial trading at the University of Virginia and author of the book Trading Catalysts: How Events Move Markets and Create Trading Opportunities.
The advent of globalization has meant that foreign markets are now moving U.S. markets. "By and large, the U.S. has moved foreign markets, rather than vice versa," according to Webb. "Though we have seen an occasional instance in which foreign markets would impact U.S. markets … it's rare for it to be the other way around and that's what's changing."
Take March 4 as an example. The Dow shot up nearly 150 points following an announcement from China Premier Wen Jiabao that the country was considering an additional economic stimulus, on top of the $586 billion spending plan already in place.
The beginning of this emerging pattern was ushered in with a bang at the end of February 2007 when China's Shanghai Composite index plummeted 8.8%, in turn causing U.S. markets to sell off about 3%.
Webb says we'll see more of it going forward, but that the magnitude and impact of overseas markets on U.S. markets will be smaller on a relative basis. An 8% decline in China, for example, wouldn't produce the same or larger effect in the United States; it would be far smaller than the impact on the home market in China. So, while this trend is growing, it will take some time before every policy action overseas has the same significance as policy actions here in the U.S.
Another reason why being an investor is better than being a trader
All this is to say that winning the trading game has taken on a new dimension. Globalization means that traders have it even tougher now. "If you're a trader it has very important implications … you need to take into account a broader range of considerations than before in terms of what factors can impact the market," Webb said. "So if you have a major market move overnight, which is every trader's worry, then obviously you're going to shorten your time horizon or put appropriate stops in place so that you would get stopped out."
Traders must now also consider whether they have any edge over predicting the actions of foreign governments.
"It's another source of volatility," said Webb. "So if you think in terms of volatility, other things equal, you're going to have slightly more volatile markets than before."
Implications for investing
Traders are clearly going to have to deal with more obstacles, but what does this mean for investors? In short, it's another factor to consider in the daily gyrations of stocks. However, if you're a long-term investor, it doesn't amount to much.
More specifically, it means that globalization is another source of volatility. It means that stocks that generate a substantial percentage of revenues overseas or whose businesses are dependent on global forces could be more volatile. Take Hewlett Packard (NYSE: HPQ ) as an example. Last year, 69% of the technology behemoth's revenues flowed from outside the U.S. Believe it or not, health and life insurance company AFLAC (NYSE: AFL ) is another, generating roughly 70% of its revenues from Japan! Oil and gas exploration and production company Anadarko Petroleum (NYSE: APC ) is an example of a company that is dependent on global forces -- the price of oil, which is driven by global demand and supply. International stocks trading on our exchanges, like CNOOC (NYSE: CEO ) or Banco Santander (NYSE: STD ) , are especially prone to more volatility, as their businesses are subject to foreign government oversight and other global economic forces.
However, globalization itself is anything but irrelevant for long-term-minded investors. It's important to pay attention to the growth of businesses in interconnected economies. Cemex (NYSE: CX ) is a great example. The Mexican cement company is reeling from a globalized business gone sour after housing markets across the world went bust. The company boomed during the last bull market cycle, acquiring companies left and right in country after country to capitalize on housing markets across the globe that were exploding. But as the housing boom collapsed in Cemex's core markets, including the U.S. and Spain, the company is struggling to meet its obligations. The company's acquisition spree, which was in part made possible through cheap debt, is coming home to roost. Cemex is struggling to refinance its debt burden, which resets this year. As a result, Standard & Poor's slashed Cemex's credit rating by five rungs to "B-" from "BB+," making it more difficult to refinance.
The banks are yet another example of the implications of globalization. Western European banks such as UBS (NYSE: UBS ) or Credit Suisse could potentially be facing another financial tsunami resulting from Eastern European debtors that are now defaulting on currency loans from Western banks, as their economies remain in freefall. The potential turmoil facing Western European banks could in turn rub off on domestic banks. Many of the Western European Banks that have transactions tied in with U.S. banks could cost U.S. banks losses on top of the toxic mortgages that have thrown a wrench into banks' core businesses. In essence, it's a domino effect that starts in one country and spreads to businesses in other countries through the proliferation of globalization.
Like it or not, globalization is here to stay. If you're a long-term investor, pay attention to the global scale of the businesses in which you invest. It could be debilitating or a real boon for a company.