Is It Time to Sell Your Foreign Stocks?

Notwithstanding the dollar's rally—and signs of a European slowdown—your money may still travel well, particularly in high-growth economies

By Christopher Farrell

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The stock prices of mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) have cratered. The bottom of the worst housing slump since the Great Depression hasn't been reached. Fears of inflation are mounting.

Yet the dollar is rallying against foreign currencies. Despite recent gyrations, the U.S. Dollar Index, a futures contract reflecting the dollar's value against six major currencies, is up 9% since reaching a recent low on July 15. The turnaround is a major factor behind the stock market's 4% gain over the same period, along with the decline in oil prices.

What does the possibility of a stable-to-stronger dollar mean for the international stocks in your portfolio? Is it time to bail? A lot is at stake: Since 2003, some $490 billion in net new cash poured into international stock funds, vs. a net $208 billion for domestic stock funds, according to the Washington (D.C.)-based Investment Company Institute. And how about foreign bonds? Thanks to the weak dollar, U.S. investors in foreign bonds have enjoyed a currency-translation boost to their yields in recent years.

Thinking through the impact of the dollar's moves used to be simpler. The old maxim was that when the dollar was strong you should flee international securities, and when it was weak you should send money overseas. But hewing to simplistic truisms is hazardous in today's quicksilver global capital markets. Profiting from any turn in the dollar's fortunes requires a more nuanced strategy now—and patience.

First of all, market veterans call for a reality check on this rally. Few expect the dollar to retrace years of losses anytime soon, and a 9% gain is tiny compared with the greenback's 50% slide against the euro and 30% tumble against the British pound over the past six years. Still, the global economic cycle may favor America's currency. While the U.S. slid into a downturn or even a recession about a year ago, only recently has growth faltered among other major industrial nations, especially in Europe. "We are picking up and they are slowing," says James W. Paulsen, chief investment strategist of Wells Capital Management (WFC).

The global business cycle should affect the gap between interest rates set by the world's central banks. There is a growing expectation that the difference in yields will narrow, especially between the U.S. and Europe. The Federal Reserve Board's benchmark rate is 2% while that of the European Central Bank (ECB) is 4.25%, and Europe could become a less attractive parking place for yield-hungry investors as the ECB combats economic weakness. "The dollar rally we have seen has been especially against the euro," says Bob Doll, vice-chairman and global chief investment officer of equities at investment management firm BlackRock (BLK). "The ECB's next move will be to lower rates, and I'm talking in months rather than years."