Content provided by Case Eichenberger, CIMA, Client Portfolio Manager

Of course they are! Are you kidding me? It’s not even close! (This is what I imagine you’re saying in your head right now.) Just take a look at the data below from two ETFs that proxy the U.S. and international stock markets: ITOT for the U.S. and ACWX for international.

As of the end of July 2017, international markets have added about 725 basis points of value over U.S. stocks.

Done. Shortest blog ever!

Not so fast. It’s important to look into what factors are contributing to the outperformance of international stocks:

  1. Lower starting valuations. Sure, those help.
  2. Improving earnings. Yes, that is a big one.
  3. GDP growth increasing and, more importantly, growing above expectations. Yes, and yes!
  4. Currency? Let’s look a little closer.

Currency is currently No. 12 on CLS’s Reasons to Invest Internationally, but favorable currency exchange rates are an important benefit to investing overseas. When U.S. investors buy into the international market through an ETF, they not only buy shares of global companies, they also buy local currencies, such as the British pound, Japanese yen, euro, and emerging market currencies. This can be beneficial, but not always.

The table below from the CLS Reference Guide offers some insight:

At certain times, the U.S. dollar performs well against other currencies and international stocks suffer, and sometimes it goes the other way. At the moment, we believe it is starting to move in favor of international currencies. (I wrote about that a little here.)

Let’s take a look at the currency impact so far this year. We can do that by looking at a few ETFs presented in the table below.

In addition to the previously mentioned ACWX and ITOT, two more ETFs help us understand this year’s currency impact. DBAW invests in the same international companies as ACWX, but hedges to the U.S. dollar, thus removing the currency impact, and USDU tracks the U.S. dollar’s movements against other major currencies.

In other words, if you happened to own DBAW this year, you could be lagging the U.S. market just slightly due to the currency impact. Note the difference of the returns between ACWX and DBAW is about the total return of USDU.

So, does CLS use any of these currency-hedged ETFs? A little, for the purpose of diversification, but not as much as the rest of the industry we compete against, as shown below (thanks to Jackson Lee for the data).

In fact, we have voted as a team to continue to increase our non-dollar exposure and let the currency diversification work in our favor. (See page 4 of the current issue of CLS Monthly Perspectives.)

Reviewing the impact of currencies on performance is always important, and it can often explain the outperformance or underperformance of an international stock market index. At CLS, we like the extra diversification we get from currencies, and we believe they can benefit the investor’s experience over time.