Many investors have noticed recently, the rapid changes in foreign currency exchange rates. How do foreign currency changes affect the value of U.S. stocks? Foreign currency exchange rates can impact U.S. stocks directly and indirectly by the economic undercurrents which change the relative value or purchasing power of a countries’ currency. The economies around the world are becoming more interrelated, and dramatic changes in foreign currency exchange rates in one market can spread quickly to the U.S. stock markets. Remember, even if you only invest in stocks of U.S. companies you already may have some international exposure in your investment portfolio.
Most U.S. Large-cap stocks derive a majority of their revenues from locations in foreign countries denominated in foreign currencies. Conversely, many Large-cap foreign companies are also affected by changes in exchange rates for revenues generated in the U.S. When the exchange rate between the foreign currency of an international investment and the U.S. dollar changes, it can increase or reduce your investment return.
How does this work? Foreign companies trade and pay dividends in the currency of their local market. When you receive dividends or sell your international investment, you will need to convert the cash you receive into U.S. dollars. Therefore, if the U.S. dollar strengthens relative to a foreign currency the U.S. company revenues abroad will be worth less, known as a foreign currency translation loss. Conversely, during a period when the foreign currency strengthens compared to the U.S. dollar, this strength increases your investment return because your foreign earnings translate into more dollars.
The value of the U.S. Dollar has increased substantially relative to most foreign currencies over the past year. Factors that have contributed to this trend include economic weakness abroad, greater U.S. energy independence and the expected rise in U.S. interest rates relative to foreign governments. This trend is expected to continue and the implications for investments in U.S. stocks should be clearly understood.
