By Mark Hulbert
Foreign stocks are the asset of choice if the U.S. dollar falls relative to other countries’ currencies.
That’s useful to know, since the nearly universal opinion on Wall Street these days is that the dollar will decline in 2021. In fact, I can recall no other occasion in my four decades of tracking short-term market timing newsletters when they collectively were more bearish on the dollar than they are now.
For this column I set out to measure how various asset classes have performed during past periods in which the dollar has fallen. I focused on the S&P 500 (S&P:SPX) , US Treasury Bonds, gold (NYM:GC00) , and international stocks (as measured by MSCI’s Europe Australasia and Far East (EAFE) index (MSCI:XX:990300) . In each case, I calculated its return relative to the U.S. Consumer Price Index.
I relied on the U.S. Dollar Index (IFUS:DXY) to determine those 12-month periods since 1980 in which the dollar fell. This index is a composite of the U.S. dollar’s foreign exchange level relative to other major currencies, such as the euro (XTUP:EURUSD) , Japanese yen (XTUP:JPYUSD) , British pound (XTUP:GBPUSD) , and the Canadian dollar (XTUP:USDCAD) . On average during these periods, the EAFE index was the best-performing asset class — with an average inflation-adjusted return of 11.7%. (See accompanying chart.)
This result should not be surprising. When the dollar is falling, foreign companies’ profits become even more valuable when denominated in U.S. dollars. During such times, you’re not only benefiting from the innate earning potential of foreign companies, but also from foreign currencies’ appreciation against the dollar.
Also not particularly surprising is the inverse correlation between gold and the dollar, since gold is often considered a hedge against currency devaluation.
Notice, however, that both international stocks and gold have lost ground over the past four decades when the dollar has appreciated. This goes to show that, whether you’re aware of it or not, you’re making a big bet on the direction of the dollar when investing in either asset class.
That should give you pause, since market timers have dismal track records when forecasting the direction of the dollar. So it is by no means a sure thing that the dollar will decline this year. If it doesn’t, it’s a good bet that both international stocks and gold will struggle.
If you’re agnostic about the dollar’s direction, U.S. stocks and bonds appear to be the safer bets. Notice from the chart that there is no significant difference between their returns in rising-dollar and falling-dollar environments.
You may worry that this result for U.S. stocks no longer applies, since as much as 50% of the revenue of S&P 500 companies now comes from outside the U.S. This does not seem to be a big worry. Since 2010, for example, the S&P 500 has produced an average inflation- and dividend-adjusted return of 10.7% in those 12-month periods in which the dollar has risen, versus 15.7% during those periods in which the dollar has fallen.
Accordingly, over the past decade there has been only a 5.0 percentage point spread between the S&P 500’s average returns during rising- and falling dollar periods. That compares to an 8.3 percentage point spread for gold and a 10.2 percentage point spread for EAFE’s return. So even in recent years U.S. stocks have appeared to be the safer bet if you’re agnostic about the dollar.
No doubt the easiest way to gain diversified exposure to non-U.S. stocks is via a mutual fund or exchange-traded fund. One of the cheapest is the Vanguard Total International Stock ETF (NAS:VXUS) , with an expense ratio of just 0.08%. In the case of gold, the largest ETF is the SPDR Gold Trust (PSE:GLD) with a 0.40% expense ratio.