Think foreign exchange rates don’t matter in today’s interconnected world of passive strategies and ETFs? Think again.
For most of the 70 plus years since World War II, America has dominated the global economy. And as a result, the US dollar has been the world’s undisputed reserve currency.
That’s still true today, despite the best efforts of some countries to diversify reserves. But the US share of global output has shrunk to 25 percent, as other economies have grown, particularly China’s. Any buy list that includes only US companies will exclude many of the world’s best growth stories, as well as emerging and established leaders in many industries. That’s a long-term prescription for mediocre returns at best.
Moreover, virtually all US investors own non-US stocks as a part of funds, ETFs and other asset pools. Shares of TransCanada Corp (TSX: TRP, NYSE: TRP), for example, are bought and sold in quantity on the New York Stock Exchange. But the pipeline company’s home market is Canada. When the Canadian dollar’s value changes, there’s an equal shift in the US dollar value of TransCanada’s share price and dividend.
The effect on returns from currency changes can be quite dramatic. US investors have taken a hit of more than 8 percent this year in Argentine stocks, solely because of weakness in that country’s currency. Conversely, Japan’s Nippon Telegraph & Telephone (Tokyo: 9432, OTC: NTTYY), a Conrad’s Utility Investor Conservative Portfolio Holding, has earned a bonus of roughly 5 percent from the appreciating Yen.
Most US companies also have global operations, which exposes their earnings to currency swings. In fact, nearly half of the revenue generated by the companies in the S&P 500 comes from outside the US. Unless hedged by currency futures, options and/or forward contracts, exchange rate changes affect earnings, dividends and share prices by an equal percentage.
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