As the U.S. economy continues to rebound and stabilize from the 2008 Financial Crisis, the U.S. dollar has recently appreciated. Expectations of the impending interest rate hike have driven the U.S. dollar higher, reflecting confidence that the U.S. economy is growing and stabilizing. Overseas, investors around the world are flocking to the U.S. dollar in hopes it will increase more. For the average person, a strong dollar is most commonly associated with imports and exports. This means U.S. imports will become cheaper while exports will become more expensive. However, there is more to the story; a strong U.S. dollar can have widespread impacts on your foreign investments from the financial markets to capital outflows.
With the world more financially intertwined, the effects of a stronger dollar can have immediate impacts on financial markets. Most large companies produce resources and revenue in the U.S. and overseas. As the U.S. dollar appreciates, this increases production costs for multinationals and consequently affects company profits. Likewise, companies operating overseas are paid in foreign currency and when that income is repatriated this means profits will be worth less. This in itself reduces the value of corporate profits and margins from overseas operations and at the end of the day reduces share prices.
A strong U.S. dollar not only impacts domestic markets but can lead to the stagnant growth of emerging bond investments. When the dollar is strong, then the return on foreign bonds is likely to fall behind the returns on U.S. bonds. This is especially detrimental for emerging markets that lack the financial credibility and comparable returns of the United States. However, this does not mean you should remove all foreign investments from your portfolio, diversification is still fundamental to any portfolio and emerging investments have the potential to sharply increase where safe investments do not.
Gaining exposure to international equities can often be a cumbersome feat. Between converting your dollars to an international currency, buying the security, and then converting back to U.S. dollars, your investment could have declined strictly on currency fluctuations. One possible way to avoid this is through currency-hedged ETFs. A currency-hedged ETF provide exposure to foreign countries while hedging against currency movements. These ETFs are becoming more attractive as U.S. investors grow concerned whether a strong dollar will reduce their returns.
Since most globally traded commodities are conducted in U.S. dollars, a strong dollar tends to increase commodity prices for countries other than the United States. This poses a problem for developing economies that tend to be big consumers of commodities they use to build infrastructure and manufactured goods. When developing countries can no longer afford to purchase necessary commodities, then demand decreases, and a strong dollar is likely to cause commodities to underperform as an investment vehicle. While U.S. consumers are thrilled about falling oil prices, producers suffer from falling prices, reduced cash flow and rendering new drilling unprofitable.
Quite possibly the biggest difference between international investing and domestic investing is the impact of currency fluctuations. When the dollar appreciates, it increases capital outflows with U.S. companies motivated to invest overseas. Investments can occur concerning physical assets or regarding mergers and acquisitions. Not only is purchasing a foreign entity more affordable with a stronger dollar, but this opens the opportunity to invert corporate operations and minimize a company’s tax burden.
The Bottom Line
International investing can be an excellent way to diversify your portfolio and gain exposure to developing countries; however a significant factor that must be considered are currency fluctuations. Since currencies vary between countries, when one appreciates relative to another there are widespread impacts to consider. It is important to remember, whenever you invest overseas, whether its equity or capital, you are betting on both the performance of the asset itself and the currency.