With recent tariff and trade news, the tone and trading of the dollar has decidedly changed. The dollar has fallen almost 10% year-to-date when measured by DXY, the U.S. Dollar index. Note, there is no absolute level of the dollar, but one that is relative to all the other currencies in the world individually. The DXY index is a measurement of many of those currencies against the dollar. 

The U.S. dollar can decline in value for many reasons—rising inflation, interest rate cuts by the Federal Reserve, increasing national debt, or geopolitical instability. When the dollar falls:

• Imported goods become more expensive, fueling inflation.
• Foreign earnings for U.S. companies may rise, especially those with overseas operations.
• U.S.-based investments may lose appeal to global investors, which can lead to sales of our bonds making interest rates higher or domestic stocks falling due to lowered interest.

To hedge against a fall of the dollar, you don’t have to invest directly in the currency.  One could always buy the currency, however, that pays no interest or dividends.  You can get foreign currency exposure directly by owning foreign equities or bonds.  Both add diversification to dollar-based portfolios.

The Role of International Diversification

For many years, the role of international equities in portfolios has come under some fire. The U.S. stock market’s outperformance over the past fifteen years has caused many to flee other international markets to chase higher returns. The strong dollar has made U.S. investments more attractive, along with the allure of U.S. tech company’s growth trajectories.

However, market cycles can change on a whim. Given the decline of the dollar and the relative valuations of international vs. U.S. equities, flows have been moving out of the U.S. market and into other international markets.

Fundamentally, having international diversification in the first place is key to a diversified portfolio. This is not a market timing decision but rather a portfolio diversifier that every investor should have regardless of the cycles. Besides geographic diversification, it’s important to know why you do it in the first place.

1. Dollar Weakness Works in Your Favor

When the dollar weakens, the value of foreign currencies rises relative to it. That means foreign stock holdings can increase in value when converted back into dollars—even if the stocks themselves haven’t moved much in their local markets.

Example: If you own shares in a Japanese company and the yen strengthens against the dollar, your investment will be worth more in dollar terms.

2. Hedging Against U.S. Economic Risks

A diversified portfolio reduces exposure to the U.S. economy’s ups and downs. While the U.S. might be facing inflation or slow growth, other economies could be booming. International stocks provide access to different economic cycles, industries, and monetary policies.

3. Access to Growth Markets

Many of the world’s fastest-growing economies are outside the U.S. Emerging markets in Asia, Africa, and Latin America may offer higher growth potential, especially during times when the U.S. economy is slowing.

4. Improved Risk-Adjusted Returns

Over the long term, combining U.S. and international equities has historically improved a portfolio’s risk-adjusted return. While not guaranteed, diversification can help smooth out volatility, particularly when currency movements work in your favor.

The overall case for international investing is as simple as taking the opportunity to diversify your portfolio risk. While nobody expects to see their purchasing power decline, it can happen. International diversification can act as a buffer to a decline in the dollar. More importantly, it can also provide additional non-correlated asset exposure to a diversified portfolio. This can not only smooth out the volatility but add to the overall return.

Source: MarketWatch

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