Why the US Dollar Impacts Global Markets

Key Concepts

• Currency Hedging/Impact: The effect of exchange rate fluctuations on investment returns for foreign investors.
• Double Tailwind/Whammy: Simultaneous positive (tailwind) or negative (whammy) effects from both asset performance and currency movements.
• Withholding Tax: Tax levied on dividends paid to non-resident investors.
• Basis Points: A unit of measurement for percentage changes, where 100 basis points equals 1%.
• Cyclical Markets: The inherent tendency of markets to move through cycles of expansion and contraction.

Currency Effects on US Stock Investments for Foreign Investors

The primary topic discussed is the recent underperformance of US stock investments for foreign investors, specifically attributed to a reversal in currency dynamics. Previously, foreign investors benefited from a “double tailwind” – strong US stock market performance and a strengthening US dollar. This meant their returns were amplified when converting US dollars back to their home currency. For example, an investor in Europe, Australia, or Asia saw significantly higher returns due to both the stock gains and favorable exchange rates.

Current Headwinds: A Double Whammy in Reverse

Currently, the situation has reversed, creating a “double whammy” against foreign investors. US stocks are underperforming, and the US dollar is weakening. This negatively impacts returns when converting US dollars back to other currencies. The speaker emphasizes that while the US stock market performance itself is a factor, the currency exchange rate is a crucial component, acting as a “headwind” for investors. Specifically, a declining dollar means that when an Australian investor, for instance, converts their US stock gains back into Australian dollars, they receive less in their local currency than they would have previously.

Additional Factors Affecting Returns

Beyond currency fluctuations, the speaker identifies two additional factors potentially impacting returns:

• Withholding Tax: A 15% withholding tax on dividends paid to foreign investors is mentioned. While a tax credit may be available to offset this, the initial deduction immediately impacts performance. The speaker advises consulting a tax professional for specific guidance.
• Fees: Investment fees, while generally small (e.g., 3 basis points for Vanguard (VO) in the US, potentially 5-10 basis points for other options), contribute to overall return reduction.

Potential Mitigation & Long-Term Outlook

The speaker suggests that opening a US-based account and funding it directly could mitigate some of these issues, potentially diversifying and avoiding currency conversion fees. However, they acknowledge the investor already appears diversified with existing US assets.

Regarding the long-term outlook, the speaker believes the currency impact is likely cyclical and will “shake itself out” over time. A future strengthening of the US dollar would reverse the current negative impact and benefit foreign investors.

Technical Details & Quantifications

• Basis Points: Used to quantify investment fees, highlighting their relatively small impact compared to currency effects.
• Withholding Tax Rate: Specifically cited as 15% for dividends paid to foreign investors.
• VO Fee: Vanguard’s US investment fee is stated as 3 basis points.

Synthesis

The core takeaway is that foreign investors in US stocks are currently experiencing underperformance not solely due to US market conditions, but significantly due to unfavorable currency movements. The weakening US dollar is eroding returns when converting back to home currencies, compounded by withholding taxes and, to a lesser extent, investment fees. While these effects are likely cyclical and will eventually correct themselves with a potential dollar rebound, investors should be aware of these factors and consider strategies to mitigate currency risk where possible.