Stronger Dollar Cuts Into Value of Foreign Stocks

A strengthening dollar could soon take the fun--and profit--out of international stock investing, which only recently became the hottest game going for individual investors.

The dollar has surged in value against key foreign currencies over the past two months, tracking the U.S. economy’s brightening prospects. The result: The value of U.S. investors’ overseas stock holdings has taken a haircut.

Take the German market, for example. The price of the average stock there fell 0.5% in November, as measured in the native currency of Deutschemarks. That was less than the 0.9% average decline of the U.S. market in November.

But the Deutschemark lost 2% of its value against the dollar during the month. In late October, it took 1.679 marks to buy one dollar. By late November, it took 1.713 marks to buy a buck.

Taken together, the German market decline and the depreciation of the mark caused a 2.5% loss for U.S. investors owning a basket of German stocks in November, according to Morgan Stanley Capital International, which tracks foreign markets.

Things were a lot worse for U.S. investors heavy into smaller European markets. The Italian lira tumbled 4.7% against the dollar in November; the Spanish peseta dove 4.5%.

For U.S. owners of diversified international stock mutual funds, however, the damage from the dollar’s muscle-flexing has so far been limited. Measured from Jan. 1, the average international fund was up 30.4% through Nov. 4, according to Lipper Analytical Services. As of last week, the average gain was 27.3%--down, but hardly out.

Currencies fluctuate constantly, of course. And the dollar has been rising against some currencies all year. The difference, until now, is that this year’s wild surge in stock prices overseas has masked the hit from currency depreciation.

Here’s the 1994 scenario that worries foreign fund managers: The U.S. economy continues to gain steam, pulling interest rates up and luring overseas cash to U.S. stocks and bonds. That keeps the dollar rising. Meanwhile, European and Asian markets pause after their sharp gains of 1993, while slowly falling interest rates in those regions keep downward pressure on their currencies.

The Japanese yen is a particular worry. The yen is one of the few currencies that has strengthened against the buck this year, jawboned up by the Clinton Administration on the hope that a cheap dollar would boost U.S. exports to Japan. It now takes about 109 yen to buy a dollar, down from 125 yen at the end of 1992.

But many experts say the yen is far overvalued at current levels. Based on “purchasing parity,” which relates exchange rates to the actual cost of goods in various nations, the yen should trade at 145 to the dollar, says Jeffery Given at economics firm Robert Genetski & Associates in Chicago.

“I see the yen going down, without a doubt,” agrees Christian Wignall, strategist at the GT Global Japan mutual fund in San Francisco.

Does that mean Wignall’s shareholders will lose? Not necessarily. Foreign-stock funds can minimize the risk of currency fluctuations with hedging techniques that offset one currency against another. The net effect, when done properly, is to neutralize foreign exchange moves.

Wignall, for example, says his Japan portfolio is 75% hedged against a decline in the yen. Similarly, at the T. Rowe Price International Stock fund in Baltimore, which owns stocks worldwide, the fund’s managers have partially hedged against a further decline in European currencies.

But many international funds, such as most of the Templeton funds, don’t hedge at all. The non-hedgers argue that it’s too complicated, too expensive (like any insurance policy, hedging costs money) and not worth it in the long run: Pick the right stocks, and they’ll do well over time regardless of currency shifts, the argument goes.

It helps the non-hedgers’ case that no one can really say what drives currencies. In theory, healthy economies should boast strong currencies. But then, how to explain the yen today?

For international fund investors who’ve bought for the long haul, the best advice is simply to make sure you’re comfortable with your fund’s investments and its hedging strategy, or lack thereof. If your fund goes down, knowing whether the cause is a temporary currency shift--or a fundamental stock-picking problem--can make the difference between whether you stay or go.

The Strong Dollar’s Bite

The dollar rose in value against most foreign currencies in November, magnifying U.S. investors’ losses in overseas stocks.

November percentage changes:

Local Stock currency Net Market prices vs. dollar loss* Germany -0.5% -2.0% -2.5% Canada -1.3% -1.2% -2.5% France -2.4% -0.8% -3.2% Netherlands -1.4% -1.9% -3.3% Spain -5.3% -4.5% -9.5% Italy -6.1% -4.7% -10.6% Sweden -8.7% -3.6% -12.0% Japan -16.1% -0.7% -16.6%

* loss to U.S. investors, after currency translation

Source: Morgan Stanley Capital International