FAQ: The Implications Of Dollar Strength
How much did the dollar rise in 2014?
The dollar strengthened in the neighborhood of 10% last year against a trade-weighted basket of international currencies. (You may hear different numbers depending on the basket used, but they will all be around 10% to 12%.)
How does dollar movement impact portfolios?
When the dollar strengthens, international investments in foreign currencies will be hurt. For example, the MSCI EAFE index of international stocks was down 4.9% in 2014. Absent strength in the dollar, this developed market benchmark would have been up 5.9%! Thatâ€™s a huge difference and a critically important factor to understanding overall portfolio returns in 2014. Any well-diversified global portfolio was materially hurt last year from dollar strength.
If currency movement can hurt that much, why bother with international investments at all?
In any particular period of time, currency has as much chance of helping investors as it does of hurting them. Indeed, at various points in history, weakness in the dollar (i.e. strength in foreign currencies) has provided a tremendous boost to U.S. [dollar-based] investors. Of course, international markets also have different economic cycles as well. This means there are periods of time when international markets deliver much better returns than the domestic market â€“ even without the impact of currency.
Canâ€™t currency exposures be hedged?
And how hedged are our typical client portfolios? Currencies can indeed be hedged back to the dollar to remove the impact of currency movement. However, hedging costs money AND you have to accurately forecast currency movements to be effective. An old adage states that the only thing harder to predict than interest rates is currency movements. Besides, currency diversification is yet another dimension to building well-balanced portfolios. As a matter of fact, in the case of international bonds, empirical studies show hedging eliminates the asset classâ€™ portfolio value entirely. An investor might as well just own domestic bonds.
Although client situations, circumstances, and investments vary, typical Summit Equities client portfolios are â€œnakedâ€ to foreign currency. That means they are not hedged. We do this because we WANT the currency diversification. Besides, we canâ€™t forecast currencies and we donâ€™t want the performance drag of continuously hedging our portfolios. Of course, from time to time we do deploy some managers that can hedge, but they do so based on their expectationsâ€“ very few do so as a matter of mandate.
What does dollar strength mean to the U.S. economy and domestic companies?
All things being equal, although a strengthening currency can be a sign of economic strength, it does not actually help an economy and more often hurts. A stronger dollar makes foreign goods cheaper to U.S. consumers while making U.S. goods/services more expensive to international buyers. This will push imports up and exports down. Thatâ€™s bad for domestic companies and bad for GDP growth. For example, now is a much better time for us to visit Europe than for Europeans to come to the U.S. It also means our domestic companies with international operations will make less money from their international businesses. This happens not only because we become less competitive in terms of pricing, but also because money earned offshore is simply worth less in dollar terms. So, our big international companies have a substantial headwind to both sales and profits â€“ an increasingly prevalent issue as companies report fourth quarter earnings and make projections for 2015. (There can exceptions to this, but they are beyond the scope of this review.)
This commentary was written on Jan. 29, 2015, by Robert W. Lamberti, CFA, Vice President of Investments of Summit Financial Resources, Inc. and Summit Equities, Inc., 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600, Fax: 973-285-3666. Source of performance: MorningstarÂ®. Indices are unmanaged and cannot be invested into directly. The investment and market data contained in this commentary is not an offer to sell or purchase any security or commodity. The MSCI EAFE Index (Europe, Australasia, Far East) is a free float- adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. Past performance does not guarantee future results. Information throughout this commentary, whether stock quotes, charts, articles, or any other statement or statements regarding markets or other financial information, are obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither we nor our information providers shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission thereof to the reader. Currency hedging is the act of entering into a financial contract in order to protect against unexpected, expected or anticipated changes in currency exchange rates. To unsubscribe from this investment commentary please reply to this email with â€œunsubscribeâ€ in the subject. Opinions expressed are subject to change without notice and are not intended as investment advice or a guarantee of future performance. Consult your financial professional before making any investment decision. Nothing in all these pages shall be construed as offering or disseminating estate, asset protection, tax and/or legal advice and we urge you to see your own attorney or tax advisor for any legal or tax questions, opinions or documents. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Securities and Investment Advisory services offered through Summit Equities, Inc., Member FINRA/SIPC, and Financial Planning services offered through Summit Equities Inc.â€™s affiliate Summit Financial Resources, Inc. 4 Campus Drive, Parsippany, NJ, 07054. Tel. 973-285-3600. Fax. 973-285-3666. CONWAY WEALTH GROUP, LLC is owned by Michael W. Conway who offers securities and investment advisory services through Summit Equities, Inc., Member FINRA/SIPC, and financial planning services through Summit Equities Incâ€™s affiliate Summit Financial Resources, Inc. 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600 Fax 973-285-3666 Direct Office Tel. 973-285-3640 20150218