Is It Time to Sell Your Foreign Stocks?

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Jesse Lefkowitz

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Yet even as the outlook for the dollar improves compared with the euro and currencies of other major developed nations, it could continue to depreciate against currencies of major emerging markets. That's an idea investors seem to be testing. The CurrencyShares Euro Trust (FXE) is down 5.7% over the past three months, for example, while the WisdomTree Dreyfus Brazilian Real (BFZ) is up 4% and the CurrencyShares Mexican Peso Trust (FXM) gained 4.1%. "Even if the decline against the euro is over, there may well be other non-European currencies that will appreciate against the dollar," says Burton G. Malkiel, an economics professor at Princeton University and author of the investing classic, A Random Walk Down Wall Street.

Why? Emerging-market growth rates dwarf those of the developed world. Their interest rates are higher, too. Over time a number of the countries will rely less on exports and more on consumers for growth. Take China: A mere 40% of its economy is driven by consumers, vs. 70% in the U.S. The move from an export-led economy to a consumer-driven one will encourage developing nations to lessen control over currency fluctuations and haltingly embrace floating exchange rates, which will allow their currencies to appreciate against the dollar.

PORTFOLIO TWEAKING

By this calculus, investors should comb through their developed world and emerging market securities and treat them differently, at least when it comes to the expected impact of currency on asset values. Long-term investors with fortitude should maintain exposure to fast-growing "frontier market" economies. But when it comes to Europe and Japan, portfolio tweaking could pay off.

Dollar strength would favor the U.S. stock market over foreign bourses. Multinationals, however, might find it tougher to outperform their smaller, more U.S.-focused brethren. The profits of U.S.-based global giants are by definition more exposed to foreign revenues. "The tailwind is morphing into a headwind," says Alec Young, international equity strategist at Standard & Poor's (MHP). But big-cap exposure to overseas economies varies greatly. Tech companies in the S&P 500-stock index get about 55% of revenues from abroad. It's 32% for large-cap financials. Even less exposed: railroads, retail food chains, and utilities.

A stronger dollar would have a bigger effect on foreign bonds. Simply put, dollar gains cut the value of interest and principal payments of foreign bonds when converted into dollars. That prospect spurred Ross Levin, head of Accredited Investors in Edina, Minn., to shift client money early this year from an unhedged foreign bond portfolio into a Pimco (PFVIX) dollar-hedged mutual fund. "We wanted to stay in foreign bonds, but take out currency risk," he says. A beefier greenback also adds to the pressure on commodity prices, which are being hurt by slowing global growth. But, cautions Peng Chen, president of Ibbotson Associates, "long-term, the fundamentals of strong demand are still there, especially given demand from emerging countries."