If you're an American investing overseas -- say, in Europe -- you might occasionally notice a distressing divergence between your portfolio and broad indexes of European stocks.
This is frequently attributable to currency swings, which can have an outsized impact on global market returns in the short term. A strong currency, for example, will dampen returns on stocks outside your country.
A weak currency will supercharge them. Many investors think this variable adds unacceptable risk to owning foreign stocks -- or that timing currency fluctuations can be a winning strategy We disagree. While in the near term, there can be dispersion created by currency fluctuations, in the longer term, the swings tend to balance out. Currency movement does not negate the benefits of diversifying globally.
So far this year, U.S. investors with a global portfolio are enjoying a solid performance. In U.S. dollars, the MSCI World Index is up 12.0% through Aug. 17. In the euro, though, the same MSCI World Index is up just 0.6%.[i]
In local currency terms -- which strips out currency fluctuations by pricing all constituent stocks in their issuing country's currency -- it is up 8.8%.[ii]
The difference is currency movement: The euro has strengthened this year against most major currencies, including rising from $1.05 to $1.17 against the U.S. dollar. That dampened returns on non-euro-denominated assets. Meanwhile, the dollar has weakened against most major currencies, boosting returns in the process.
If you are in euroland, you might look at this with some frustration right now. If you're American, you are either pleased or fret that it will reverse soon. Whatever your take, we counsel patience -- currency fluctuations aren't a call to action. It is commonplace amid bull markets to see currencies cycle from weak to strong to flattish and back. Trying to time them is a fool's errand.
Currency movements depend heavily on relative interest rate expectations. Currency traders tend to seek higher yield, selling currencies in nations where they expect lower rates and buying in those where they anticipate increases.
Hence, repositioning your equity portfolio based on currency fluctuations requires forecasting relative interest rates across much of the developed world. Tough to do, given the multitude of inputs, including central bankers' actions, which aren't predictable even in one nation--much less multiple.
But the good thing is currency effects frequently flip fast, so any detraction likely won't persist long. Consider Exhibit 1. In it, we plot the difference during this bull market between MSCI World rolling 12-month returns in U.S. dollars, euro, the British pound and Canadian dollars minus local currency returns.
When the line(s) are above zero, a weak currency is boosting returns in the indicated currency. When below zero, a strong currency is dragging down returns.
Exhibit 1: The Currency Effect on Global Returns, March 2009 - July 2017
Source: FactSet, as of 8/18/2017. Rolling 12-month return, MSCI World Index with net dividends (monthly) in USD, GBP, EUR and CAD minus return in local currency.
The lesson is clear: No matter which major currency you pick, all have alternated during this bull market between having a negative impact and a positive one. Ultimately, in our view, currency impact is too fleeting and weak to offset global investing's benefits: Diversifying political or country-specific risk; increasing your opportunity set; and gaining exposure to areas with stronger fundamentals or weaker sentiment.
Focusing on only your home country's stocks because of currency effects eschews these big benefits in exchange for currency stability that typically doesn't amount to much in the longer term.
[i] Source: FactSet, MSCI World Index return with net dividends in USD and EUR, 12/30/2016 - 8/17/2017.
[ii] Ibid. MSCI World Index return with net dividends in local currency, 12/30/2016 - 8/17/2017.
Fisher Investments is an independent, fee-only investment adviser serving investors globally. To learn more about Fisher Investments, please visit www.fisherinvestments.com.