By Bennett Whitlock
One of many variables that can affect investment performance is fluctuation in the value of currencies. In general, American investors focus primarily on how the U.S. dollar compares to currencies of other countries. It isn’t easy to forecast likely investment outcomes based on the direction of these markets. But it is helpful to understand how changes in the value of the dollar on global currency markets could play a role in an investor’s portfolio.
When the dollar weakens
The dollar has been strong recently (more on that below), but it hasn’t always been that way. At the start of 2014, it cost approximately $1.35 to convert U.S. currency to one euro (Europe’s common currency), or $135 in American dollars to obtain 100 euros1. In this period where the dollar was relatively weak compared to the euro, it was more expensive for Americans to travel in Europe.
This environment was, however, beneficial to U.S. companies that sold goods into European markets. Because the euro was stronger than the dollar, American-made goods were less expensive for Europeans to purchase. This helped generate business and profits for multi-national firms based in the U.S. Investors who owned stocks in those companies may have benefited from that trend.
Other investment advantages of a weak dollar
Along with benefiting U.S. companies selling goods abroad, the declining value of the dollar also may have helped American investors who purchased overseas investments (such as a mutual fund that invests in stocks based in other countries). Overseas investments are purchased in the local currency. Subsequently, if the foreign currency gains value versus the dollar, the payoff to American investors increases when the investment is sold. In this situation, U.S. investors may stand to benefit even if the investment itself generates little or no return.
For example, if an investor purchased the stock of a German company for 100 euros and the exchange rate was $1.25 to the euro, it would cost him or her $125 to buy a share of the stock. If the price of the stock remained unchanged over a period of time, but the dollar weakened to $1.35 to the euro, the investor could sell a share of the stock for the same 100 euros and now receive $135 for it after converting the proceeds back to U.S. currency. From a currency perspective alone, the transaction resulted in an eight percent gain for the investor.
The story today – a stronger dollar
Since 2014, the dollar has gained significant strength against most foreign currencies. For example, as of December 1, 2016 the exchange rate for one euro was $1.052. This has been great for Americans vacationing in Europe because the cost of exchanging dollars into euros is far less expensive than just a few years ago. But the dollar’s growing strength has altered the environment for U.S. companies doing business abroad and Americans investing in overseas markets.
U.S. companies selling goods overseas are receiving a lower return when they convert back to the dollar compared to a few years ago. That could have a negative impact on their profits, which potentially detracts from stock performance. (Keep in mind that currency is one of many variables affecting company profits.) Unlike the previous example of the weakening dollar, an investor who bought a global mutual fund now and chooses to sell it has to overcome the impact of potential currency losses due to the dollar’s stronger position.
An unpredictable market
The direction of currency markets is extremely difficult to predict. A variety of factors, such as the strength of countries’ economies, inflation rates, interest rates and political developments, can impact currency valuations on a day-to-day basis.
Investors who purchase stock in companies with significant overseas business should understand that currency movements may affect their investment performance. The same is true if he or she invests in vehicles such as global equity and bond mutual funds. Investors should exercise caution before basing investment decisions on projections of trends in this highly unpredictable market.
1 Yahoo! Finance, “EUR/USD Historical Data: Exchange rate $1.3559/euro,” Jan. 1, 2014. (finance.yahoo.com/quote/EURUSD%3DX?p=EURUSD%3DX)
2 Yahoo! Finance, “EUR/USD Historical Data: Exchange rate $1.0582/euro,” Dec. 1, 2016. (finance.yahoo.com/quote/EURUSD%3DX?p=EURUSD%3DX)
Bennett C. Whitlock III, CRPC®, is a Private Wealth Advisor and Managing Director with Whitlock Wealth Management, a private wealth advisory practice of Ameriprise Financial Services, Inc. He offers fee-based financial planning and asset management strategies and has been in practice for 22 years. To contact him call 703.492.7732 or visit his website at whitlockwealth.com
12848 Harbor Dr., Suite 101 Lake Ridge, VA 22192.
Foreign investments subject the fund to risks, including political, economic, market, social and others within a particular country, as well as to currency instabilities and less stringent financial and accounting standards generally applicable to U.S. issuers.
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