Currency Fluctuations Don’t Offset Global Investing’s Benefits

In the short-term, currency swings can have an outsized impact on global market returns. A strong currency, for example, will dampen returns on stocks outside your country. A weak currency will supercharge them. This leads many investors to either try to time currency moves or outright eschew global investing, thinking such currency fluctuations add huge risk. 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.

This year to date, US investors with a global portfolio are enjoying a solid year. In US dollars, the MSCI World Index is up 12.0% through August 17. In 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 US dollar. That rising euro 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 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 those they anticipate rising. 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 US dollars, euro, sterling 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.

Another way to see this: Exhibit 2 plots this bull market by its year of age (March 9 to March 9). The green numbers indicate a currency effect that boosted returns in the currency shown. Red indicates a strong currency caused detraction.

Exhibit 2: This Bull Market's Currency Impact-Flips and Flops

Source: FactSet, as of 8/18/2017. MSCI World Index return with net dividends in USD, GBP, EUR, CAD and local currency, 3/9/2009 - 8/17/2017. Bull market years are March 9 - March 9. *3/9/2017 - 8/17/2017.

Look at the rotation! No matter which currency you pick, all have alternated 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.