The U.S. stock market has put together an impressive run of all-time record highs for nearly a year and a half now, with both the Dow Jones Industrials (DJINDICES:^DJI) and the S&P 500 (SNPINDEX:^GSPC) climbing sharply in 2013 and adding modest gains so far this year. America's strength is even more noteworthy compared to the tough times that Europe is facing right now, with a sluggish economy struggling to climb out of recession and stock markets badly underperforming the U.S. so far this year.
Yet as much as America has managed to avoid Europe's fate, there's one big reason why the U.S. is anything but safe from what's happening across the Atlantic. Below, you'll learn the haunting truth about what Europe's woes have done to global markets and how they're already having a huge impact on some of the best-known American companies in the world.
Falling confidence in the eurozone
When you look at major stock markets in Europe, including the U.K., Germany, and France, the first thing you'll note is that, surprisingly, major stock indexes in those countries have actually risen this year. France leads the way with a 3% jump, and Germany and Britain have barely eked out positive gains of about 1% each. When you factor in even better performance from smaller markets like Italy and Spain, broad-based euro-area benchmarks are up about 4% so far in 2014.
The problem for U.S. investors in those markets, though, is that those gains are measured in the local currencies of each respective market, including the British pound and the euro. The strength of the U.S. dollar has more than offset the local-currency gains in major eurozone markets, leading to losses of 2% to 5% for American investors in dollar terms.
The reason for the drop in European currencies against the dollar has to do with the different parts of the business cycle each economy is in. In the U.S., policymakers expect that the economy is ready to sustain growth without so much monetary-policy accommodation, suggesting that the long-awaited rise in interest rates could finally come next year and push up the value of the currency along with it. But in Europe, the European Central Bank is fighting low inflation levels with ever more accommodative policy moves, including the aggressive decision to send certain key interest rates into negative territory for the first time ever. As a result, foreign-exchange traders continue to favor the U.S. dollar and its potential for higher returns.
Why America's at risk
Given how U.S. markets have climbed while Europe is straggling behind, the risk to America's record market run might not be obvious. But the main problem is that so many major U.S. corporations have deep ties to Europe, and a strong dollar has already started eroding the earnings and revenue growth that some of those companies have seen from Europe over their long history of doing business there.
Many companies get a large chunk of their revenue from Europe. For instance, most investors see McDonald's (NYSE:MCD) as an American icon, but few realize that the fast-food giant actually gets more revenue from Europe than from any other part of the world, with European sales beating out U.S. revenue by more than 25% in 2013. McDonald's has had plenty of operational woes worldwide as it seeks to adapt to a changing industry environment. Yet the strong dollar reduces the value of the foreign-currency sales McDonald's generates, making it even harder for the restaurant chain to produce the profit growth investors want to see.
In other cases, Europe doesn't constitute as large a portion of overall sales, but it provides substantial profits due to higher margins. Coca-Cola (NYSE:KO) is a good example of this phenomenon, as the company got only about 11% of its overall revenue from the continent in 2013. Yet when you look at pretax profits, Europe was Coca-Cola's most successful geographical segment, inching out Latin America and easily beating the North American division despite its having more than four times the sales.
Obviously, some parts of the U.S. stock market focus more exclusively on the American market and stand to benefit from Europe's problems rather than suffering from them. But given the age of the bull market in the U.S. and the prevalence of increasingly global companies making up larger parts of the overall stock market, American investors need to take a close look at their portfolios to identify companies with international risk.
In the long run, Europe is likely to bounce back, and investors who comb Europe's economy for the companies most likely to profit from an eventual recovery will see themselves richly rewarded. But for America's record run, the lingering impact of Europe's currency woes is a constant threat to further gains for U.S. investors.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and McDonald's. The Motley Fool has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.