Is The Dollar Falling Out of Favor?

Chart of the Week for December 8-14, 2000

Currency valuation has always been an integral part of international diversification. Given the relative strength of the dollar lately, U.S. investors with assets in international stocks have been disenchanted. Returns on these investments, which were already disappointing in local terms, were trimmed even further when converted into U.S. dollars. As a result, some investors either reduced or completely eliminated their international positions in favor of U.S. stocks.

However, the historic performance of the dollar shows that the currency tide has not always favored the dollar. From that perspective, it may not be the most sound investment strategy to follow (or chase) the currency tide in search of higher returns. Such strategy could prove delusive.

Looking at the graph on the right, the euro has been rebounding since November 24, lifting the MSCI EAFE Index with it. Indeed, since Nov. 24 the euro has appreciated 5.3% against the U.S. dollar, enabling the international index to rise 3.2% even though it fell (0.2)% in local terms. The Nasdaq Composite fell (3.7)% for the same period, while the S&P 500 index and the Dow rose only 0.7% and 1.9%, respectively.

Now may be the time to reconsider international stocks, as a turnabout for the euro may be on the horizon. That would certainly benefit these stocks. But, taking the long-term view, investors should not let short-term currency fluctuations scare them off international stocks. Over the long term, currency effects wash out of international equity performance.

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