The Currency Curse: How A Weak Dollar Is Amplifying Stock Market Losses For Foreign Investors

The recent downturn in the US stock market has been painful for investors, but for foreign investors—particularly those in Europe—the losses have been even more severe. This is due to a compounding factor: the weakening of the US dollar. As the greenback declines, the value of US investments in foreign currencies shrinks, exacerbating losses and disrupting a long-standing trend where currency gains helped cushion stock market declines.

For years, European investors benefited from a "virtuous cycle" in which strong stock market performance was accompanied by a rising dollar. This dynamic not only boosted their returns but also encouraged further investment in US equities. However, with the dollar now slumping alongside the stock market, those benefits have reversed, leaving foreign investors facing larger-than-expected losses.

The Virtuous Cycle: How Currency Strength Previously Helped Foreign Investors

Historically, European and other foreign investors in US stocks enjoyed a dual benefit. Not only did their equity investments appreciate, but the US dollar often strengthened at the same time. This meant that when they converted their returns back into euros, pounds, or other home currencies, they gained an extra boost from the exchange rate.

A strong dollar also created a self-reinforcing cycle: as European investors bought more US stocks, they needed to convert their euros into dollars, which increased demand for the currency. This helped push the dollar higher, further improving returns on unhedged investments. This dynamic made Wall Street an attractive destination for global capital, fueling the impressive bull run seen in recent years.

The Dollar’s Decline and Its Impact on Foreign Investors

However, this cycle has now broken. The US dollar has weakened, reducing the value of US assets when converted into foreign currencies. This has magnified stock market losses for European investors, who are now seeing declines on both fronts.

For instance, the S&P 500 is down nearly 4% in dollar terms so far this year. But for European investors, the losses are even worse—over 8% in euro terms. This difference is entirely due to currency depreciation, turning what might have been a manageable decline into a more painful financial hit.

Several factors have contributed to the dollar’s slide. The Federal Reserve’s shifting stance on interest rates, economic concerns, and changing global capital flows have all played a role. As the dollar loses its strength, it no longer provides the buffer that foreign investors once relied on.

Why This Time Is Different: Market and Currency Shifts

In previous downturns, the dollar often held steady or even strengthened as investors sought safety in US assets. This helped offset stock losses for foreign investors. But this time, several key factors have changed:

• Shifts in Interest Rate Expectations: The Federal Reserve has signaled a more cautious approach to rate hikes, reducing the dollar’s appeal compared to higher-yielding currencies elsewhere.
• Global Capital Flows: With economic uncertainty rising, investors are diversifying away from US assets, weakening demand for the dollar.
• Economic Slowdown Concerns: Fears of slower US growth have made the dollar less attractive relative to other currencies, particularly in Europe.

These changes mean that the traditional safety net provided by the dollar is no longer in place, making US stock market declines more painful for foreign investors than in past cycles.

Investment Strategies: How Foreign Investors Can Manage Currency Risk

For investors facing these challenges, mitigating currency risk has become crucial. There are several strategies that can help protect returns in a volatile exchange rate environment:

• Hedging Currency Exposure: Investors can use financial instruments like currency futures or options to protect against exchange rate fluctuations. While this adds cost, it can help reduce potential losses from a weakening dollar.
• Diversification Across Markets: Instead of concentrating investments in US stocks, foreign investors can spread their portfolios across multiple regions to reduce reliance on any single currency.
• Safe-Haven Assets: During times of market and currency volatility, assets like gold, Swiss francs, and Japanese yen can provide stability.
• Investing in US Companies with Global Revenue Streams: Companies that earn a significant portion of their income outside the US may be less affected by dollar weakness, as they benefit from revenue in stronger foreign currencies.

Conclusion: The Future of US Stocks for Foreign Investors

The end of the "virtuous cycle" of rising US stocks and a strengthening dollar has created a more challenging environment for foreign investors. With the dollar now working against them, European investors must be more cautious about currency risk and its impact on their returns.

Looking ahead, whether this "currency curse" persists will depend on macroeconomic factors, central bank policies, and global capital flows. If the dollar stabilizes or strengthens again, foreign investors may regain some of their lost advantage. Until then, those with US stock exposure must navigate a new reality where currency movements can turn a market correction into a much deeper financial hit.

Author: Brett Hurll