Currency Impact on Stock Returns

Currency movements can significantly impact your investment returns, sometimes adding gains and sometimes erasing them. Whether you own international stocks, ADRs, or even US multinationals, exchange rates play a crucial role in your portfolio's performance. Understanding this relationship helps you make better investment decisions.

How Currency Affects International Investment Returns

When you invest in foreign assets, your return has two components: the asset's return in local currency and the currency return.

The Dollar Return Formula

The precise formula for calculating dollar returns on foreign investments:

Dollar Return = (1 + Local Return) x (1 + Currency Return) - 1

Using the example above:

Dollar Return = (1 + 0.15) x (1 - 0.09) - 1 = 1.15 x 0.91 - 1 = 4.65%

This formula shows that currency can either amplify or dampen your returns, sometimes dramatically.

Currency Impact on US Multinationals

Even domestic US stocks are affected by currency movements. Many S&P 500 companies generate significant revenue overseas:

• Technology: Apple, Microsoft, Google - 50%+ international revenue
• Consumer Staples: Coca-Cola, P&G, McDonald's - major global presence
• Industrials: Caterpillar, Boeing - significant export business
• Healthcare: Pfizer, Johnson & Johnson - global drug sales

Historical Currency Impact Examples

Real-world examples illustrate how currency movements affect returns:

2014-2015 Dollar Rally:

The Dollar Index rose nearly 25%. US multinationals reported significant earnings headwinds, with companies like Microsoft citing billions in currency translation losses. International stocks in Euro and Yen terms outperformed their dollar-denominated returns.

2017 Dollar Weakness:

The Dollar fell about 10%. International stocks delivered extra returns for US investors, and multinational earnings got a currency boost.

2022 Dollar Strength:

Aggressive Fed rate hikes strengthened the Dollar significantly. Emerging market stocks suffered not just from local declines but additional currency losses. US multinationals reported major currency headwinds.

Winners and Losers from Dollar Movements

Different stocks respond differently to Dollar strength or weakness:

Strong Dollar Benefits:

• US importers (lower cost of goods)
• US consumers (cheaper foreign goods)
• Companies with foreign expenses but domestic revenue
• US travelers abroad

Strong Dollar Hurts:

• US exporters (less competitive pricing)
• US multinationals (lower translated earnings)
• Emerging market borrowers (dollar-denominated debt harder to service)
• Commodities priced in dollars (appear more expensive globally)

Weak Dollar Benefits:

• US exporters (more competitive abroad)
• US multinationals (higher translated earnings)
• Foreign tourists visiting US
• Commodities (cheaper for foreign buyers)

Managing Currency Risk

Investors have several options for managing currency exposure:

1. Natural Diversification

Over long periods, currency movements tend to even out. A diversified portfolio with multiple currency exposures provides natural hedging.

2. Currency-Hedged ETFs

These funds use currency forwards to neutralize exchange rate movements. Examples include:

• HEDJ - WisdomTree Europe Hedged Equity
• DXJ - WisdomTree Japan Hedged Equity
• HEFA - iShares Currency Hedged MSCI EAFE

3. Tactical Currency Views

Some investors adjust hedging based on their currency outlook. This adds complexity and requires accurate currency forecasting.

4. Focus on Companies with Natural Hedges

Some multinationals have matched revenue and expenses in foreign currencies, reducing translation impact.

Currency and Sector Performance

Different sectors have varying currency sensitivities:

• Technology: High international exposure, significantly impacted by Dollar movements
• Utilities: Mostly domestic revenue, minimal currency impact
• Materials: Commodity prices and global demand create complex currency relationships
• Consumer Staples: High international exposure for major brands
• REITs: Primarily domestic, limited currency impact
• Energy: Oil priced in Dollars creates unique dynamics

Reading Earnings Reports for Currency Impact

Companies often disclose currency impacts in earnings reports. Key phrases to look for:

• "Foreign exchange headwind/tailwind"
• "Constant currency growth" (growth excluding FX effects)
• "Currency translation impact"
• "Transactional currency exposure"

When a company reports 3% revenue growth but 7% constant currency growth, you know currency cost them 4 percentage points of growth.

Currency Impact on Dividends

For international dividend investors, currency adds another layer of complexity:

• Foreign company dividends paid in local currency translate to varying dollar amounts
• ADR dividends are converted at prevailing exchange rates
• Dividend yield calculations can be misleading when currency is volatile

When to Worry About Currency

Currency risk matters more in some situations than others:

Currency Risk Matters More When:

• You have concentrated exposure to one foreign currency
• Your investment horizon is short (less than 5 years)
• Currency is experiencing extreme volatility
• You need predictable cash flows from international investments

Currency Risk Matters Less When:

• You have diversified exposure across many currencies
• Your time horizon is very long (10+ years)
• The local asset returns are much larger than currency movements
• You are reinvesting rather than withdrawing

Practical Portfolio Considerations

Here are actionable steps for managing currency in your portfolio:

1. Know Your Exposure

Calculate what percentage of your portfolio has foreign currency exposure, including indirect exposure through multinationals.

2. Consider Your Goals

If you need stable dollar returns in the near term, hedging makes more sense. For long-term growth, unhedged exposure may be fine.

3. Monitor the Dollar

Watch the DXY (Dollar Index) and major exchange rates. Extreme moves may warrant portfolio adjustments.

4. Diversify Broadly

Exposure to multiple currencies provides natural diversification better than concentration in one foreign currency.

Summary

Currency movements are an inescapable part of global investing. They can boost your returns when trends are favorable or erode gains when currencies move against you. Understanding how exchange rates affect your portfolio - from direct international holdings to US multinationals - helps you make informed decisions about hedging, diversification, and position sizing. While currency cannot be predicted reliably, being aware of your exposure and its potential impact prepares you for whatever exchange rates do next.

Want to learn more? Read our guide to forex basics for traders or explore global market correlations.