For many investors, the only time you may think about foreign exchange rates is when you're planning to go on an overseas trip. But looking at the fluctuations of the U.S. dollar against its international counterparts can give you extremely valuable information not just about the foreign exchange market but also about macroeconomic trends that have a major impact on your stock portfolio.
Where the dollar's been
The U.S. dollar has been on a huge, roller-coaster ride over the past few years. During the financial crisis, it acted as somewhat of a safe haven, but during 2009 it fell sharply as overseas economic prospects seemed more favorable than U.S. economic growth.
That changed in a hurry with the onset of Europe's troubles. Ever since then, the dollar has gone back and forth with the euro, with each one advancing when the other faced threats to its fiscal health and economic growth.
The mistake that most people make in evaluating the dollar, however, is looking too closely at the Dollar Index. Because that index started before the creation of the euro, it included several different currencies that the euro has now replaced. As a result, the euro has a huge weighting on the Dollar Index.
Looking at other major currency pairs gives more insight, however:
- With the high prices of gold and other metals as well as oil, the currencies of resource-rich countries have tended to hold up very well. Both Canada's and Australia's dollar now trade near or above parity with the U.S. dollar, and as long as demand keeps metals and energy prices high, their currencies should continue to do well.
- The Japanese yen has been on a long-term uptrend for decades. A recent decline had some convinced that the island nation's export industry might finally have succeeded in turning the tide and getting the yen moving in a more favorable direction for them, but the yen has regained much of its lost ground in the past few months.
- After a speculative push that boosted the Swiss franc to almost $1.40, the Swiss National Bank instituted an artificial peg, tying the franc's value to the euro at a rate of 1.2 francs per euro. So far, that limit has held, but some are making big bets that the peg may eventually fail.
- Emerging-market currencies have been mixed. The Brazilian real and Indian rupee have both fallen sharply in response to their slowing economies, but the Chinese currency has stayed roughly in its steady range as it slowly appreciates against the U.S. dollar.
Why does this matter?
Even if you never set foot outside the country, currency fluctuations have a big impact on your investments. That because the companies you invest in do have substantial overseas businesses, and they have to translate revenues from around the world back into their home currencies all the time.
The effect of currencies is most obvious during earnings season. Procter & Gamble (NYSE: PG ) has seen headwinds from the strong dollar recently, which forced it to reduce earnings outlooks early this year. Because of its complete focus on overseas sales, Philip Morris International (NYSE: PM ) constantly has its results buffeted by foreign-exchange factors.
Even small companies can feel the pinch. For instance, Federal-Mogul (Nasdaq: FDML ) specifically cited the weak euro and strong dollar as a big factor in its 37% drop in earnings during the first quarter.
More broadly, exchange rates can give you hints about capital flows in and out of different countries, which can have a big impact on their stock markets. Brazil, for instance, has used various currency-related policies to try to clamp down on rampant speculation in its financial markets. It seems to be working; despite massive oil finds off the Brazilian coast, Petrobras (NYSE: PBR ) shares have plunged in the past year.
Should you play?
If you want, investing directly in currencies is easier than ever. With ETFs, you can choose from just about all the major currencies and several niche markets as well. Even short-term traders have gotten in on the forex market with the ProShares UltraShort Euro ETF (NYSE: EUO ) letting you make leveraged bets on the euro's decline.
But the more important lesson is that even if you never become a currency speculator, following foreign exchange markets can give you insight into the stocks you own. That's reason enough to pay attention even when you don't have a big trip planned.
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