How Global Trade Affects the Dow

The stock market is looking muted this morning following Census Bureau release showing a narrower-than-expected trade deficit in April. Although the monthly deficit widened slightly from March, the overall trend has been downward over the past year and a half or so. Comments from various Fed speakers today are expected to send the markets oscillating, but as of 10:55 a.m. EDT, the Dow Jones Industrials sit at breakeven, with the broader market benchmarks marginally higher.

But many investors don't understand just how trade figures affect the Dow and its components. One of the largest factors sending the trade deficit lower in recent years has been the re-emergence of stronger U.S. domestic energy-production as unconventional sources of crude and natural gas have led to sharp declines in imports. In fact, refining companies have turned to exporting some energy products to other countries in order to take advantage of price disparities in the international markets. Although Dow energy giants ExxonMobil and Chevron haven't seen the explosive growth that smaller players in shale-gas plays around the country have experienced, the vertically integrated oil companies have nevertheless benefited from domestic production increases, which have contributed to greater profits in their refining and marketing divisions.

More broadly, trade deficit figures often reflect currency fluctuations, and changing foreign-exchange rates also have a huge impact on the Dow's 30 components. Although a few of the Dow's members do most of their business in the U.S., most of them are large multinationals with a big presence abroad. What's been somewhat surprising is that even as the dollar has strengthened in recent months, making it more difficult for U.S. exporters to compete, the trade deficit hasn't responded by reversing course and moving higher.

Nevertheless, you can expect to see the impact of the strong dollar in earnings reports from many Dow components for the second quarter starting next month. McDonald's and Procter & Gamble have both shown a lot of sensitivity to currency fluctuations in the past. McDonald's has increasingly relied on its global business reach, getting more than two-thirds of its revenue outside U.S. borders. For its part, P&G gets 65% of its sales from its international division, and earlier this year it took a hit when Venezuela devalued its currency, showing how a rising dollar can hurt the consumer giant.

Keeping an eye on trade figures is important, especially for Dow components with big operations overseas. If current economic tensions among major trade partners ever escalate to more serious problems, then it could have a huge impact on the Dow and the entire stock market.

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Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Chevron, McDonald's, and Procter & Gamble. The Motley Fool owns shares of McDonald's. 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.

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