Data provided by Bloomberg

These tools help to show the cyclical nature of currencies. The periods between 1997-2002 and 2015-2017 show the dollar trading at ten year highs. During the period from 2004-2012, the dollar traded at ten year lows. While periods of dollar strength or weakness can persist for years, historically speaking, the dollar has neither strengthened nor weakened indefinitely. Eventually, the cycle changes, as we all learned in economics class.  When it does, it can have big impacts on relative returns of US and international equities.

Conclusion

Investing is an increasingly global endeavor. According to Standard & Poor’s, in 2015, 44.3% of S&P 500 company revenues were generated outside the United States. Because so many US companies are multinational in nature, some investors argue holding a portfolio of exclusively US stocks is sufficient diversification because these companies do much of their business overseas. Along with the fact that investing in local companies helps to capture diversification through global economic cycles, this approach fails to recognize another key component of international stock returns – the change in value of the dollar.

Many businesses want to lock in or hedge currency movements so that they can focus on their core products and limit the effects of currency movements on their revenues and profits. Due to this reality, exposure to U.S. companies is not necessarily an adequate way to diversify currency exposure. We feel investors should maintain foreign currency denominated investments for diversification – especially maintaining this discipline following periods of dollar strength.

ETFs offer hedged and non-hedged currency choices. With TOPS, we utilize hedged positions such as BNDX for fixed income. However, we do not hedge currency risk for equities. While the full scope of the reasoning is beyond this article, currencies impact fixed income to a greater degree than equities, and we want the underlying fixed income fundamentals to drive returns, rather than the currency movements. Likewise, hedging currency in some markets can be cost prohibitive.

Predicting changes in trends is difficult. Even though patterns emerge over long time frames, currency movements are notoriously difficult to predict in the short run.  Much of the dollar strength of the past 5-7 years has been due to stronger US economic growth and higher interest rates relative to Japan and Europe. It’s unclear exactly what may catalyze a change from dollar strength to dollar weakness, as periods of both can persist for years until they eventually change. Even so, the weight of the evidence suggests that maintaining international exposure is still an important part of a well-diversified portfolio. Likewise, the direction of the dollar will have a large impact on the relative performance between domestic and international equity performance.

This article was written by Ryan Gilmer, CFA, who is Vice President – Investment Management at TOPS ETF Portfolios, a participant in the ETF Strategist Channel.

Disclosure Information

ValMark Advisers, Inc. (“ValMark”) is a federally registered investment adviser located in Akron, Ohio. ValMark and its representatives are in compliance with the current registration and notice filing requirements imposed upon federally covered investment advisers by those states in which ValMark maintains clients. For registration or additional information about ValMark, including its services and fees, a copy of our Form ADV is available upon request by contacting ValMark at 1-800-765-5201.

This article provides commentary on current economic and market conditions and is not directly relevant to any particular client account. The information contained herein should not be construed as personalized investment advice or recommendations to buy or sell any security. There can be no assurance that the views and opinions expressed in this article will come to pass. Investing involves the risk of loss, including the loss of principal.

Diversification cannot assure gains or protect against losses.

Past performance is no guarantee of future results. Information contained herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.  Indexes are unmanaged and cannot be directly invested in.

Source: Bloomberg for historic price and return references.

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